MONETARY POLICY AND THE STATEOF THE ECONOMY, PART II

HEARINGBEFORE THE

COMMITTEE ON FINANCIAL SERVICESU.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

FEBRUARY 16, 2007

Printed for the use of the Committee on Financial Services

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HOUSE COMMITTEE ON FINANCIAL SERVICES

BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, PennsylvaniaMAXINE WATERS, CaliforniaCAROLYN B. MALONEY, New YorkLUIS V. GUTIERREZ, IllinoisNYDIA M. VELAZQUEZ, New YorkMELVIN L. WATT, North CarolinaGARY L. ACKERMAN, New YorkJULIA CARSON, IndianaBRAD SHERMAN, CaliforniaGREGORY W. MEEKS, New YorkDENNIS MOORE, KansasMICHAEL E. CAPUANO, MassachusettsRUBEN HINOJOSA, TexasWM. LACY CLAY, MissouriCAROLYN MCCARTHY, New YorkJOE BACA, CaliforniaSTEPHEN F. LYNCH, MassachusettsBRAD MILLER, North CarolinaDAVID SCOTT, GeorgiaAL GREEN, TexasEMANUEL CLEAVER, MissouriMELISSA L. BEAN, IllinoisGWEN MOORE, Wisconsin,LINCOLN DAVIS, TennesseeALBIO SIRES, New JerseyPAUL W. HODES, New HampshireKEITH ELLISON, MinnesotaRON KLEIN, FloridaTIM MAHONEY, FloridaCHARLES WILSON, OhioED PERLMUTTER, ColoradoCHRISTOPHER S. MURPHY, ConnecticutJOE DONNELLY, IndianaROBERT WEXLER, FloridaJIM MARSHALL, GeorgiaDAN BOREN, Oklahoma

SPENCER BACHUS, AlabamaRICHARD H. BAKER, LouisianaDEBORAH PRYCE, OhioMICHAEL N. CASTLE, DelawarePETER T. KING, New YorkEDWARD R. ROYCE, CaliforniaFRANK D. LUCAS, OklahomaRON PAUL, TexasPAUL E. GILLMOR, OhioSTEVEN C. LATOURETTE, OhioDONALD A. MANZULLO, IllinoisWALTER B. JONES, JR., North CarolinaJUDY BIGGERT, IllinoisCHRISTOPHER SHAYS, ConnecticutGARY G. MILLER, CaliforniaSHELLEY MOORE CAPITO, West VirginiaTOM FEENEY, FloridaJEB HENSARLING, TexasSCOTT GARRETT, New JerseyGINNY BROWN-WAITE, FloridaJ. GRESHAM BARRETT, South CarolinaRICK RENZI, ArizonaJIM GERLACH, PennsylvaniaSTEVAN PEARCE, New MexicoRANDY NEUGEBAUER, TexasTOM PRICE, GeorgiaGEOFF DAVIS, KentuckyPATRICK T. McHENRY, North CarolinaJOHN CAMPBELL, CaliforniaADAM PUTNAM, FloridaMARSHA BLACKBURN, TennesseeMICHELE BACHMANN, MinnesotaPETER J. ROSKAM, Illinois

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel

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CONTENTS

PageHearing held on:

February 16, 2007 1Appendix:

February 16, 2007 51

WITNESSES

FRIDAY, FEBRUARY 16, 2007

Bernstein, Jared, Senior Economist, Economic Policy Institute, Washington,D.C 6

Blackwell, Ron, Chief Economist, American Federation of Labor and Congressof Industrial Organizations (AFL-CIO) 8

Blank, Rebecca M., Gerald R. Ford School of Public Policy, University ofMichigan 11

Grant, James, Editor, GRANT'S Interest Rate Observer 14

APPENDIX

Prepared statements:Bernstein, Jared 52Blackwell, Ron 68Blank, Rebecca M 74Grant, James 90

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Hon. Barney Frank:New York Times article by Bob Herbert, dated 1/22/07, "Your MasterCard

or Your Life" 95

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MONETARY POLICY AND THE STATEOF THE ECONOMY, PART II

Friday, February 16, 2007

U.S. HOUSE OF REPRESENTATIVES,COMMITTEE ON FINANCIAL SERVICES,

Washington, D.C.The committee met, pursuant to notice, at 10:03 a.m., in room

2175, Rayburn House Office Building, Hon. Barney Frank [chair-man of the committee] presiding.

Present: Representatives Frank, Maloney, Watt, Moore of Kan-sas, McCarthy, Lynch, Scott, Green, Cleaver, Sires, Hodes, Ellison,Klein, Wilson; Bachus, Lucas, Paul, Gillmor, Jones, Capito,Neugebauer, Putnam, Blackburn, and Roskam.

The CHAIRMAN. Today's hearing of the Committee on FinancialServices will come to order. Would members of the staff pleaseclose the doors? This is a continuation of a hearing on MonetaryPolicy and the State of the Economy, and today we have a panelof four economists. Three were selected by the majority, one by theminority, and we think they represent a good panel of people to ex-press their views on the subjects that are covered in the MonetaryReport that are covered in the Humphrey-Hawkins bill that are be-fore us today.

The key issue, I believe, before the country economically is howto continue and perhaps improve on economic growth in a mannerthat more fairly distributes the proceeds of that growth. No seriousindividual is trying to do away with inequality. Inequality is a driv-er of the capitalist economy, and it serves us well. But too muchinequality can become socially problematic, it can become economi-cally problematic, and it can become politically problematic. Andthe task I believe, for us, is not to do away with inequality, as Isaid, but to try to have public policies that contain it so that thereis enough inequality to provide the incentives that the systemneeds to be productive, but not so much as to become socially, eco-nomically, and politically counterproductive.

Now politically, it is clearly counterproductive now. Whether ornot it is socially, and whether or not it will become so economically,remains to seen. I would note that the Federal Reserve Chairmanand others have cited the great strength of consumer spending aswe go forward in the economy, but a number of people, including,I believe, the gentleman from Connecticut, Mr. Shays, yesterdayraised a kind of paradox, which is that consumers are being toldtwo things: One, to consume; and two, to save. And you cannot con-sume and save the same dollar, at least not legally. So the issuethen becomes do the consumers have enough to do both? And that's

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the economic problem. You can reach a point where there is simplynot enough money going to the great bulk of citizens for them todo both. And it does appear right now that consumption is beingmaintained, but to some extent at the expense of savings. I've hadfriends in the financial community who are concerned about thelow savings rate in America, the negative savings rate in somecases, saying to me, "Don't you think we need to do things to helpthe average citizen save more?" My answer is yes, begin by lettinghim or her have more money. For people who have run out ofmoney by the end of the month, there is no incentive in the worldthat is going to get them to save. They cannot save what they donot have, and I think that is the problem.

And, of course, it is also the case that Henry Ford, when he de-cided to pay the workers $5 a day and was chided by some of hisfellow industrialists for profligacy, made the very sensible state-ment that if he didn't pay them, they couldn't buy the cars. Youcan't have a mass production economy without mass consumption.And he, although he was a raving anti-semitic lunatic in other con-texts, he was a pretty good economist as well as obviously a greatindustrialist, showing that intelligence does not necessarily jumpfrom area to area.

But that's the dilemma we have, and I do think it is clear thatcertainly politically we have reached a point where excessive in-equality has become a cause of political gridlock, not just in Amer-ica, but elsewhere. You see it in Latin America with the increasingsuccess of some politicians winning elections who many in Americadisagree with. And I must say I think it is far healthier to haveelected officials like Lula and Kirshner than Morales and Chavez,but we are, I think, undercutting the responsible democratic left.

In America, it is clear to me that as trade promotion expansion,trade promotion authority expires, it will not be renewed in thecurrent context. A Doha Round is unlikely probably because of re-sistance from many of my colleagues in the areas that representagriculture, agriculture apparently being an exception in the mindsof many of my conservative friends to all the doctrines of free en-terprise and little government that they otherwise support.

But apparently Von Mises has a footnote that says that none ofthis applies to agriculture. It's apparently written in German, so Icouldn't understand it, but my colleagues from the agriculturalarea apparently all seem to understand it.

But if they got a Doha Round, I don't think it would pass theHouse. We are bringing out a bill from this committee on foreigninvestment, direct foreign investment, which is clearly in the inter-est of the United States and of our workers. It is more controver-sial than it ought to be, because there is this fear on the part ofthe average American that foreign economic activity somehow willundercut them. I think it is wrong in this case, but it is not wrongin general. So that is the subject that I hope we will be able to ad-dress. I think all of us want to see growth go forward.

And I will just close by saying I was troubled by what seemedto me some bias that had crept in—well, not crept in, that ispresent in the Federal Reserve's approach, where in the FederalReserve Monetary Report they say three things. One, production inAmerica is now below capacity, will remain below capacity for sev-

eral quarters, and is expected to reach capacity, not to go above it.Two, inflation appears to be diminishing. Three, therefore, ourmajor concern is inflation.

That does not compute. That bespeaks a bias, and while I do notbelieve—I think we've gotten proof that growth alone is not a suffi-cient basis for the kind of economy we want, it certainly is a nec-essary one. So as bad as things are when growth is not fairlyshared, they would be worse if growth is diminished. And that isthe set of problems we have today.

And I believe now I will turn to the gentleman from Texas, theranking member of the subcommittee, for his time.

Dr. PAUL. Thank you, Mr. Chairman. I want to thank you forholding these hearings, and I am very pleased that you do have aninterest in monetary policy, because over the years, I have empha-sized monetary policy as being very important. I think it's fre-quently neglected.

There was a time that the Humphrey-Hawkins type of hearingsthat we've had semi-annually emphasized the issue of moneygrowth and how this affected the economy. That is no longer thecase; as a matter of fact, it's been de-emphasized. The Federal Re-serve no longer even reports M3, as if total money supply has noimportance, and yet there are some who think it still is important,even though most of us recognize that measuring money in this ageof global financing has become more difficult.

Most of the time when we, in the Congress, and other economiststalk about the Federal Reserve, they talk about the fixing of inter-est rates on the overnight rate and its influence. Generally speak-ing, they're dealing with central economic planning rather thandealing with the currency itself. I like to think more that the roleof the Federal Reserve ought to be to guarantee that we have a sta-ble value of the dollar rather than concentrating on prices. Becauseif we have a dollar that falls in value, and prices go up and youconcentrate on the prices, then the policies are directed toward ris-ing prices and not to the cause of the inflation, which happens tobe the inflation of the dollars themselves.

The other thing that has always concerned me over the years hasbeen the neglect in emphasizing that there are other things thatoccur when a central bank increases the supply of money. Not onlymight it lead to higher prices—the one thing is, you don't know ex-actly which prices will go up. Sometimes they're in the financialmarkets and sometimes they're in the asset markets.

But there also tends to be a neglect of some other consequencesof what the Federal Reserve does. For instance, even if prices hap-pen to be relatively stable because of increased productivity, gen-erally, everybody is reassured. Well, there's no inflation. And theyfail to recognize that there are other consequences of Federal Re-serve monetary policy such as the misdirected investment, themalinvestment, the accumulation of debt, and the formation of bub-bles. And if we look at our history, we know something about bub-bles. We know about NASDAQ bubbles. We know about housingbubbles and the various different portions of the economy that willget out of control.

So, I am very pleased that we are having these hearings withthis emphasis on Federal Reserve and monetary policy, and also

the important issue that we have been dealing with more recently,that of transparency of the Federal Reserve. And though therehave been some new items introduced, like the release of the min-utes, and we know a little bit more a little faster about the FederalReserve, what's going on, we still don't know the details of inter-national transactions, the international conversations and whattype of agreements there might be with central banks, which Ithink are very important.

These are the kinds of things that I hope we can move forwardand for which Congress will assume more responsibility. It is theCongress that is responsible, and I think we have been derelict inmany ways of delivering so much of this responsibility to the Fed-eral Reserve, and in many ways, the Congress, as it has in otherareas in recent years, has not had adequate oversight, so I like theidea that we will have more oversight.

I have had concerns about the President's working group on fi-nancial markets, and not too many people talk about it or knowabout it, and quite frankly, even as a member of the Banking Com-mittee, I wish I knew more about it. I haven't been getting infor-mation, and to me, that is rather significant if there is a group. Weknow the group exists, we know they meet, but we don't knowwhat they do, and I'm hoping I get cooperation on the committeeso we can find out more about how they do and what their plansare and what their intents are. That to me, is very important.

So, with that in mind, more transparency and more concentra-tion on the value of our money and how it affects the distributionof wealth in this country, there is a saying that goes when you in-flate a currency, there is a redistribution of wealth and it leavesthe poor and the middle class and goes to the wealthy, and thereare some statistics that point this out. And that's one of the rea-sons the working class can't keep up, because they suffer morefrom the inflation.

And with that, I yield back to the chairman.The CHAIRMAN. The Chair apologizes. The gentleman has con-

cluded. The gentleman from North Carolina, then we'll go to thegentleman from Illinois.

Mr. WATT. Thank you, Mr. Chairman. I'll be brief, although Iwouldn't bet you that it would be the 1 minute that I told you itwould be. I'm not betting, but I'm going to try to stay within thatminute.

The CHAIRMAN. 10 seconds gone.Mr. WATT. I walked into the discussion when the Chair was talk-

ing about Chairman Bernanke's statement that we wanted to bothincrease savings and increase consumption at the same time andhow that may be difficult to do or impossible to do. I'm wonderingwhether, in the course of this discussion today, somebody can ad-dress the concern I have that there probably is actually a negativesavings going on that's feeding this consumption in the sense thatmy sense is that most of the consumption that's taking place witha number of my constituents is taking place with borrowed money.It's not coming at the expense of savings, it's coming at the expenseof negative savings, because people are borrowing money to con-sume. And it would be helpful in this discussion today to see how

this massive increase in personal debt that we are observing playsinto this whole equation that we're discussing for the last 2 days.

And with that, I'll yield back.The CHAIRMAN. I thank the gentleman. Since he did leave us

some time, I would ask him to yield for the purposes just of saying,and he reminded me to do something. Bob Herbert of the New YorkTimes did a very good column a while ago about the extent towhich credit card debt and bankruptcies based on credit card debthave in some cases resulted from the need to pay medical bills bypeople who had no other alternative. And I would ask that the arti-cle which references a broader study be made a part of the record,because that's exactly the problem the gentleman was talkingabout, and it clearly is directly relevant here.

Mr. WATT. Just to reclaim my time for a second. That's part ofit, but that's at least a mandatory expenditure when you're talkingabout medical expenditures. A lot of what I'm talking about is dis-cretionary expenditures, which is not in an emergency medical situ-ation of that kind. I just think people are putting more and moreand more debt onto credit cards at the expense of savings of anykind, really getting further and further into a negative savings sit-uation.

The CHAIRMAN. The gentleman is correct. The gentleman from Il-linois.

Mr. ROSKAM. Thank you, Mr. Chairman. I just want to thank youfor holding these hearings and really setting the tone in terms ofa macro level. I think you made a very interesting point about sortof the orthodoxy of the free market. I ran into that in the Illinoislegislature where we would all sort of worship at the altar of localcontrol until our ox was being gored, and then suddenly we wouldall sort of manipulate things around.

But I think yesterday we heard some very interesting news, andI think encouraging news from Chairman Bernanke, and that isthat the economy is strong, and I just want to point out a coupleof those elements and then speak directly to what I think are someof the challenges that we face.

3.4 percent growth in 2006 with 7.5 million new jobs createdsince 2003, no small task. Unemployment is low comparatively, 4.6percent in 2006. Inflation is under control. It fell from 3.4 percentin 2005 to 2.5 percent in 2006. And our productivity is up by 2.2percent, and of course we've all been reading about how the stockmarket is exceedingly strong.

But there are still some challenges that are out there. We heardthem yesterday a little bit, and that was a discussion or allusionsat least to long-term entitlement costs and devising new ways totrain dislocated workers and workers who are coming into theworkforce.

I think it's important as we begin these conversations to realizethat all of us on this committee, and I think all of us in Congress,agree that it's essential to help those in the lower wage portionsof the economy to improve their earning power, but I don't thinksome of the rhetoric that has bubbled over characterizing all ofthese positions as merely Wal-Mart jobs or low skill jobs is accu-rate. In fact, Chairman Bernanke said yesterday, "There certainly

has been job creation at the high level as well as throughout thedistribution of wages."

And at that, higher wage jobs, the problem is often that there'snot enough skilled workers to fill that demand. And I agree withhim. I have run into this problem in terms of interacting with man-ufacturers in my district, which is the west and northwest suburbsof Chicago, who are having a very difficult time filling competitiveslots based on training levels.

So it's my hope that this will turn into a frank and positive dis-cussion and that we avoid can some of the pitfalls that sometimescome up in economic conversations. We need to find ways to createand promote economic growth, but in my view, protectionismdoesn't work, can't work, and will ultimately hurt our economy. AsI've interacted with manufacturers, particularly in my district,they've said, "Look, we don't need help from that point of view. Wejust need help being more competitive here and at home." Andwe've all heard and seen egregious examples of CEO compensationthat's been reported in the news media, but I think we risk killingthe goose that lays the golden eggs if we overly regulate in thatarea. I think we need to create greater transparency. Again, my ex-perience in Illinois has run its economy down considerably, nowranking 46th out of 50 in job creation due to a high regulatory en-vironment.

Mr. Chairman, our success has always been tied to an ever ex-panding wave of social and economic opportunity for citizens, andthat's why I believe that our best solution involves finding newways to empower our citizens. I look forward to hearing these wit-nesses and their testimony, and I yield back the balance of mytime. Thank you.

The CHAIRMAN. I thank the gentleman, and we will now get toour panel of witnesses who are being called upon in alphabeticalorder so that no one reads significance into it. And the first witnessis Dr. Jared Bernstein, who is director of the Living Standards Pro-gram, the Economic Policy Institute and has been a very, in myjudgment, welcome contributor to the policy debates we've beenhaving in recent years about this very set of topics.

Dr. Bernstein.

STATEMENT OF JARED BERNSTEIN, SENIOR ECONOMIST,ECONOMIC POLICY INSTITUTE, WASHINGTON, D.C.

Mr. BERNSTEIN. I thank Chairman Frank, Ranking MemberBachus, and the members of the committee for our opportunity totestify on the critical issue of the importance of full employment intoday's economy.

In recent months, top policy officials and economic commentatorshave wondered why there seems to be more economic anxietyamong working Americans than might be expected, given the lowunemployment rate and solid macro economy.

While some officials remain puzzled by this apparent disconnectbetween macro performance and perceptions of economic wellbeing,a quick look at some relevant data suggests it should not be sucha head scratcher. After rising at rates close to that of productivityover the latter 1990's, the real wage of the typical worker, the me-dian wage, flattened in real terms, as did the average real wage

of high school and even college graduates. After rising along withproductivity growth over the latter 1990's, the real median incomeof working age families fell 5 percent or $3,000 since 2000.

In fact, the latter 1990's were anomalous. For most of the past3 decades, real middle wage and income growth has occurred at apace far below that of productivity growth. The economist's mantra,rising productivity growth boosts living standards, now begs thequestion: Just whose living standards are being lifted?

Two of the main reasons for the evolution of this productivity in-come gap are the absence of full employment and the loss of workerbargaining power. My key points today are truly tight labor mar-kets are critically important for middle income working families. Ina labor market that lacks the institutions and the norms to provideworkers with some bargaining power in a global economy wherethose whose access to power and assets gives them a huge upperhand in the distribution of wealth, the predictable outcome is pre-cisely the surge in inequality we've seen over the past few decades.In this context, full employment is one of the few reliable sourcesof bargaining power available to the American worker today.

Now one reason for this imbalance has been the allegiance to a"natural rate" theory of unemployment. Despite little evidence tosupport its contemporary use, this theory has led policymakers togive greater weight to inflation relative to unemployment concerns,and this has been partly responsible for years of unnecessary slackin the labor market. Economic elites have been operating from aplaybook with an inherent bias against broadly shared prosperity.

Now the views of many economists and the policymakers whostill heed their advice are driven by the belief that there is this so-called "natural rate" of unemployment, the rate below which infla-tion would not merely rise, it would continually accelerate until un-employment went back up to the so-called "natural rate." The Con-gressional Budget Office currently sets this rate to be 5 percent.

Like many other economists today, I consider this concept to bea poor guidepost for policymakers. Events have overtaken the origi-nal model, and the evidence I present below suggests that sub-scribing to the model risks persistent and unnecessary slack in theeconomy, wasting billions of dollars, and consigning millions of po-tential workers to fewer job opportunities and lower wages thanshould be the case.

We're not denying that a relationship between unemploymentand inflation exists. We do, however, deny that policymakers caneffectively identify the so-called "natural rate" and that unemploy-ment below that rate leads to spiraling inflation. To the contrary,I provide evidence that when unemployment has fallen below thenatural rate, middle-income families have prospered and viceversa. Tight labor markets are a critically important ingredient toa balanced economy where the benefits of growth are broadlyshared.

Let me take a few moments to clarify these claims. First, the un-employment rate has been below 5 percent for over a year. Are wenot currently at or at least close to full employment? And second,given that we're below this alleged natural rate that I claim loomslarge in economists' thinking, why has the Federal Reserve notraised interest rates since last June?

On the first point, while the current job market is relatively tightand a lot tighter than it was for the first few years of this recovery,our workforce has not enjoyed a sustained period of full employ-ment in this business cycle, and the result has been the absenceof broadly shared economic gains.

Second, while concerns about tight job markets generating wagepush inflation are of course evident in their statements and speech-es, the actions of neither the later years of the Greenspan Fed northe Bernanke Fed appeared to be dominated by concerns about thenatural rate. And to their credit, both men have consistently prac-ticed a more nuanced version of monetary policy than would be thecase if they were bound by the belief that unemployment below 5percent would automatically lead to spiraling wage growth.

Allow me to demonstrate the points I'm trying to make here witha table that I handed out to all the members on the committee.They contrast two periods with very different outcomes for the me-dian family. They are also two periods where the goals of macro-economic policy were quite different.

Using historical estimates of this natural rate, we can determinewhen the actual unemployment rate was above or below the sup-posed floor in the job market. In truly full employment periods, theunemployment rate will be below the natural rate and vice versa.Between 1949 and 1973, as the table that I handed out shows, theunemployment rate was often below the natural rate, cumulatively19 percentage points. This happens to be about the same numberof points that unemployment was above the natural rate in the lat-ter period. Not only was middle income growth much higher in theperiod when we were often below the natural rate, but inflationwas lower as well.

Clearly, from the perspective of middle class incomes, and espe-cially for minority families, for whom full employment has consist-ently made a huge and positive difference, tight labor markets,even below the supposed natural rate were associated with muchbetter income growth.

Thank you.[The prepared statement of Mr. Bernstein can be found on page

52 of the appendix.]The CHAIRMAN. Thank you. Next, sticking with my alphabetical

order, which the gentleman from Alabama is helping me master,we will hear from Mr. Ron Blackwell, who is the chief economistfor the AFL-CIO.

Mr. Blackwell.

STATEMENT OF RON BLACKWELL, CHIEF ECONOMIST, AMER-ICAN FEDERATION OF LABOR AND CONGRESS OF INDUS-TRIAL ORGANIZATIONS (AFL-CIO)Mr. BLACKWELL. Thank you, Chairman Frank, Ranking Member

Bachus, and other members of the committee for the opportunityto be here and to testify on behalf of the 10 million members of theAFL-CIO and its affiliated unions on the economy and the conductof monetary policy.

I should begin by acknowledging that I happen to sit on theboard of the Baltimore branch of the Richmond Federal ReserveBank, but I'm appearing here today exclusively as a representative

of the AFL-CIO, and nothing I say is intended to express thethinking of either the Richmond Bank or the Board of Governors.

The CHAIRMAN. Unfortunately.Mr. BLACKWELL. Our view of monetary policy, like our view of

economic policy in general, proceeds from a single important cen-tral fact of our times, which is that in the richest country in thehistory of the planet, it's increasingly difficult for people to makea living by working.

We have a $13 trillion a year economy, and it's growing at over3 percent a year, while real family incomes have stagnated. Therupture between productivity and wages that Dr. Bernstein men-tioned is one of the signal facts of our time. I think I understandthe diagram that you're looking at.

If you look at the early period of the post-war period, the periodwhen the middle class was built, we had very rapid economicgrowth, over 5 percent a year. Rapid productivity growth and realwage growth tracked productivity step for step. That was the mostrapid increase of living standards not only in the United States'history but in world history.

But the period after that is very different. Today, we believe that3 percent is a very rapid pace of economic growth. Productivitygrowth is growing today very strongly, at least since 1995, butwages have been stagnant. The increase in productivity since 1973is something like 67 percent, contrasted with 100 percent increasein the earlier period. But real wages have increased by 8 percent,8 percent compared to 67 percent.

The only reason—and family incomes have gone up by somethinglike 15 percent. But the only reason they've gone up is becauseeach worker is working more hours per job. Each worker is work-ing more jobs on average. And most importantly, each family issending more of its members to work, placing enormous strains onthe working family.

And of course, there's the borrowing of money against risinghousing prices, first and foremost, but in general, rising indebted-ness of households as they try to maintain living standards in astagnating environment.

Moreover, economic insecurity is on the increase, as the chancesof a working family losing 20 percent of its income in any 2-yearperiod have doubled since 1980. And with 46 million people withno health insurance in this country, despite the fact that we spendmore per capita on healthcare than any country in history, andwith the shift by employers from defined benefit to defined con-tribution plans, which it's estimated by Ed Wolfe at NYU, has basi-cally left older Americans aged 55 to 60 with lower net worth thantheir parents had, despite all the increases in wealth over the pastgeneration.

So we basically have a situation where workers are struggling tomake a living in the midst of the most prosperous country in thehistory of the world. And this is what—the stagnation of wages andthe rupture between productivity and wages, which used to be thestandard of fairness in our country, is one of the things that's driv-ing inequality. Today the United States has the most unequal dis-tribution of income and wealth in the developed world, and we're

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more unequally developed today in terms of income and wealththan we have been since the 1920's, and we're headed backwards.

There are many causes for this stagnation of wages and thegrowing inequality, but I think we have to rethink our country'seconomic policy if we're going to be able to respond to this andallow our country to grow together again instead of growing aparteconomically, politically and socially.

The core issue, and Dr. Bernstein mentioned this, but I want tostress it, these various policies have shifted the balance of bar-gaining power from working people, whether they're in a union ornot, to their employers. And the employers are using this increasedrelative bargaining power to reduce wages, keep productivity gainsfor themselves in the form of higher profits, shareholder pay, CEOpay, but also to walk away from their responsibilities forhealthcare provision for their employees and for the retirement se-curity of their employees.

And the solution to this, I mean, the guiding thread of economicpolicy from our point of view is that we have to enact economicpolicies that rebalance power between working people and the peo-ple for whom they work. And in doing so, it's not against these em-ployers. We need great American companies led by far-sightedbusiness leaders, and we understand the increased competitivepressure they're under from globalization and other forces. But wedo have to find a way in this new global economy to balance thispower between working people and their employers.

We proceed on economic policy and monetary policy from thepoint of view of the values of American working people, and fourof those, in particular, are very important to mention.

The first one is that anybody in this country who wants to workshould have a job. It's a terrible thing when people are left, as amatter of government policy, unemployed, as we currently do mil-lions of people, unemployed, looking for a job, and unable to findone because of our policy of controlling inflation.

Second, if anybody does work in this country, their familyshouldn't be living in poverty. And their family members, especiallytheir children, should have access to healthcare, and they shouldhave some reasonable hope that at some point in their working lifethey could stop working and live a dignified retirement.

Third, if they want to associate with their brothers and sistersat work and form a union, they should be able to.

And fourth, in conclusion, we know we live in a global economy,but American workers want to have a strong American economy,one that pulls its weight in the world and that is internationallycompetitive. The fact that we're borrowing 6 percent of our GDP toconsume things that we no longer produce is a problem from thepoint of view of the sustainability of our country's competitiveness,and it's a problem for American working families.

But in this context, the very foundation of economic policy is thefirst value. If someone wants to work in this country and improvetheir living standards and that of their family through their ownefforts, the government should assure that they have a job to oc-cupy. This was recognized in 1946 in the Employment Act, and in1978 in the Humphrey-Hawkins Act. But the conduct of monetarypolicy since that time has narrowed the dual mandate of the Fed-

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eral Reserve to maximize employment on the one hand, maintainprice stability on the other. That is has been effectively narrowedbecause of this NAIRU concept, on to inflation fighting. Hence, theirony that you were noting, Mr. Chairman, about the fact that in-flation is still our biggest concern even though there's no sign ofit anywhere.

I want to recommend shortly, briefly in closing that instead ofnarrowing the mandate of the Federal Reserve, we need to broadenand bring up to date that mandate. We currently have an economy,as mentioned by Mr. Bernanke as a strong economy. The currentrecovery is the weakest in terms of job creation of any recoverysince the Second World War. And wages and productivity are stilldividing. It's higher now than it was when the recession began.Our employment population is lower. We need to broaden it to in-clude a genuine full employment and establish full employment asthe foundation of our economic policy.

Thank you very much.[The prepared statement of Mr. Blackwell can be found on page

68 of the appendix.]The CHAIRMAN. Thank you. Next is Dr. Rebecca Blank, who is

the Joan and Sanford Weill Dean of the Gerald R. Ford School ofPublic Policy at the University of Michigan, and I assume by thetime you go back, they will have found someone to name the Stateof Michigan after so that they can maximize the deference that wepay.

Dr. Blank.

STATEMENT OF REBECCA M. BLANK, GERALD R. FORDSCHOOL OF PUBLIC POLICY, UNIVERSITY OF MICHIGAN

Ms. BLANK. Thank you, Chairman Frank, Ranking MemberBachus, and the distinguished members of the committee. I'm de-lighted to be here this morning. I want to give you just a few factsabout life for low-skilled workers in America. I want to say some-thing about the implications of rising inequality and then closewith a very, very brief discussion of the policy implications.

It has always been clear that the most important policy to assistless-skilled workers is a healthy macroeconomy with strong jobgrowth. There has historically been a strong positive correlation be-tween unemployment rates and poverty rates. When unemploy-ment rises, so does poverty. It is worth noting that inflation actu-ally has little correlation with poverty among non-elderly adults. Atthe bottom of the income distribution, keeping employment high issignificantly more important than keeping inflation low.

A primary reason why unemployment and poverty are stronglycorrelated is that unemployment tends to be concentrated amongless-skilled and lower-wage workers. If you look at the trends inunemployment by skill over the past 25 years, three points becomevery quickly apparent. One, unemployment rates are substantiallyhigher among less-skilled workers than more-skilled workers. Two,unemployment is much more cyclical among less-skilled workers.When jobs become scarce, those who lose their jobs first are thosewho are lower wage. Three, while overall unemployment rates doremain quite low at present, the unemployment rates among less-

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skilled workers still are relatively high, higher than they were, forinstance, at this point in time in the expansion of the 1990's.

Unemployment rates of course are only an imperfect indicator ofwhat's going on in the labor market, and many people also look atlabor force participation rates. Trends in labor force participationrates show a very interesting divergence by gender. Labor forceparticipation rates among less-skilled men have been falling stead-ily, even through the rapid economic expansion of the 1990's, whilethey've been rising among less-skilled women. I might note thosefalls in labor force participation among less-skilled men are par-ticularly strong among African American men in communities ofcolor.

It's important to understand why labor force participation amongless-skilled women is going up, while it's going down among men.Part of the answer is microeconomic policy, which, I realize, is notthe jurisdiction of this committee. There have been changes interms of welfare reform, in terms of expansion in the earned in-come tax credit, in child care subsidies, and in Medicaid that havemade work more attractive, particularly for less-skilled women.

But policy changes at the micro level are only one part of thestory. Macroeconomic shifts in demand are also very important.And the changes in relative wages that both of the previous speak-ers have referred to are a major reason for declining labor forceparticipation among less-skilled men. Calculations of inflation-ad-justed median weekly wages indicate that women who are highschool dropouts have seen their weekly wages rise by 14 percentover the last 15 years. Men who are high school dropouts have ba-sically seen no change whatsoever in their wages.

In short, as wages have changed in this economy, both less-skilled men and women have fallen further behind their more-skilled brothers and sisters. The job market has simply gottentougher for less-skilled workers. But other changes among women,growing work experience, changes in policy, and greater returns toexperience have offset these problems and led to somewhat greaterwage increases and hence greater workforce participation.

And as others also have noted, this rising inequality of wagesalso reflects itself in rising inequality in household incomes. Someof that has been offset by the fact that more people are working,and working harder, so rises in household inequality are not quiteas great as rises in wage inequality.

So why should we care about rising inequality? I think there areat least three reasons. First, there's a sense of economic depriva-tion among lower-income families as they watch others move fur-ther ahead. Tuition for higher education is increasing faster thaninflation. Housing and rents in many areas are going up fasterthan inflation. Healthcare is almost impossible to purchase if youdon't get it through your employer. Lower-wage workers in today'seconomy are finding it harder to achieve those things that are partof the American Dream: a house; a job with pension and healthbenefits; and the opportunity to send their children to college.

Second, economic inequality is linked with other types of socialinequality. Health disparities between more- and less-skilled work-ers have risen. Differences in educational achievement between thebest and the worst students have risen. These social inequalities

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only reinforce economic inequality, and most troublesome, theylimit opportunities for the children of today's lower-wage workers.Quite a bit of evidence now suggests that economic mobility isgreater in many European countries than it is in the United States.

Third, economic inequality and a sense of relative deprivationhave negative effects on the civic and the political realm. The eco-nomic experiences of the past 2 decades are simply different forthose with a college education as opposed to those with a highschool education. Fear of technological change and growing eco-nomic internationalization is fueling a backlash that will lead tobad policies that limit future economic growth. Public discussionsof Social Security reform or health insurance are simply hard tohold when the bottom third of the population is going to retire onlyon Social Security and Medicare, while the top third has extensivemarket investments and long-term supplemental health insurancethrough their employer.

In short, economic inequality makes it harder to solve our com-mon problems, and harder to evoke a sense of common purpose andexperience. This is not only inconvenient for politicians, it threat-ens the civic nature of public debate in a democracy.

What should we be thinking about on the policy front? ChairmanBernanke, in a recent speech, called for investments in educationand training to moderate inequality, and he's absolutely right. Inthe long run, more Americans need more and better education. Butby itself, that's not a complete strategy. Three additional policy em-phases need to be considered.

First, we need a strong labor market with growing demand forworkers at all skill levels. This means macroeconomic policies thatpromote stable economic growth and low unemployment among all.

Two, we need to maintain and expand our policies that subsidizework for the least skilled and that encourage adults to take andkeep jobs. This committee, I know, is focused primarily on macro-economic issues, but the answers to these questions will also in-clude some more specific focused microeconomic policies, such asexpansions in the earned income tax credit, a moderate minimumwage level at levels similar to where it's historically been set, andassurances that low-income families have healthcare available tothem.

Third, and finally, it is important to think creatively about waysto make sure that all Americans benefit from the economic growththat is resulting from our recent economic changes. There are twoways to redistribute the benefits of these changes more broadly.First, we do redistribute some of it through the tax and transfersystem through such things as the earned income tax credit or bet-ter healthcare. But secondly, we can assist those workers who aredisplaced by new technologies or by shifts in where goods and serv-ices are produced. Policies such as wage insurance, aimed at cush-ioning income losses for displaced workers, can help America'sworkers adjust to a changing economy.

Work is a good thing in the lives of adults. It produces income,a sense of self-value, and demonstrates that an individual hasskills to contribute to the society. We should do all we can to en-courage men and women to acquire the skills and work behaviorthat allows them to support themselves and their children, but we

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should also do all we can to guarantee there are jobs available tothose who work, and to ensure that those who demonstrate theirability and their willingness to work are able to support themselvesand their families.

Thank you.[The prepared statement of Ms. Blank can be found on page 74

of the appendix.]The CHAIRMAN. And to introduce our final witness, the Chair rec-

ognizes the gentleman from Texas.Dr. PAUL. Thank you, Mr. Chairman. I would like to welcome

Mr. James Grant, who is a financial journalist and the editor andfounder of the GRANT'S Interest Rate Observer. He's also writtenseveral books on finances as well as even been involved in writinghistory books. So I welcome Mr. Grant today.

Thank you.

STATEMENT OF JAMES GRANT, EDITOR, GRANT'S INTERESTRATE OBSERVER

Mr. GRANT. Thank you, Chairman Frank, Ranking MemberBachus, and distinguished members of the committee. The cur-rency that the Federal Reserve sponsors is the greatest achieve-ment in the history of money. It is a miracle. It is uncollateralized,and has been since 1971. Nothing tangible stands behind it. It ispurely faith-based, and yet this piece of paper of no intrinsic valuepasses from hand to hand, and they're nice to have as well. Andso 30 years have passed since Humphrey-Hawkins enjoined theFed to promote full employment and to promote a sound dollar.Those 30 years have by and large passed the Federal Reserve by,it seems to me. The Federal Reserve is a financial institution ofmoderate size. Morgan Stanley's balance sheet is bigger than theFed's. The Fed holds $850 billion or so of government securities.The foreign central banks together hold an admitted $1.6 trillion,and the Federal Reserve has one policy tool at its disposal, andthat is to manipulate a single interest rate.

Now when Pope Julius II said to Michelangelo, "Go paint the Sis-tine Chapel," he did not say, "Here is your roller." And yet thisblunt tool is what the Fed has. A roller, however, has never de-stroyed an industry nor stymied an economy, but the black art ofprice control is just that dangerous. The Fed essentially is in thebusiness of price control. It is not so different than the late andunlamented Interstate Commerce Commission, nor the unreformedTexas Railroad Commission. It is in the business of picking a rateout of the air and imposing that rate on a market.

Now people acting in markets are not infallible, nor are peoplein bureaucracies always in error. But I think we have come to be-lieve, all of us in economics and finance, that by and large, pricesdiscovered are better than prices imposed. And yet the Fed imposesa price. The Fed is well-intentioned and smart, too—so many col-lege-educated economists—but the rate that the Fed imposes is notalways the rate we ought to have.

Consider, for example, the 1 percent rate the Fed gave us frommid-2003 through mid-2004. You'll recall at the time that the spec-ter of deflation loomed over the American economy. So far as Icould tell, that was a specter of every day low and lower prices.

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However, Chairman Bernanke, and then-Chairman Greenspan,who had previously sung the praises of globalization and high pro-ductivity growth, now decided that those things, in fact, posed adistinct menace.

And to save us from a price level too low, an inflation too low,they went out and ordered the printing of more money. ChairmanBernanke was especially vivid in that mission, reminding us thatthe Fed could, if it wished, drop dollar bills from aircraft, which Igather the Fed has done in Baghdad. But this was in the UnitedStates. So 1 percent was the rate for a full 12 months.

Not since the second Eisenhower Administration had anythinglike that been seen. The result was a great rush of prosperity intoresidential mortgage finance and into housing. Housing for thenext several years generated fully 40 percent of private sector em-ployment growth. Everybody and his brother—you didn't have toapply for a loan any more. They came to you. And this was fine.It was good for the working man, it was good for the families.Home ownership, a great, an inherently great good, one hears,went up and up.

And now we no longer have a 1 percent interest rate. The Fedhas decided that the market needs a 5.25 percent interest rate. Inconsequence, there is a small but significant and growing and fi-nancially worrisome problem with mortgage finance. The so-called"subprime" area of our mortgage market is in disarray.

Interest rates are the traffic signals of a market economy, andwhen they are all switched to green, there is bound to be confusionat the intersections and a certain number of pileups. We havetalked about growth and opportunity. Everyone wants the samething. The question is, can the Fed deliver those things through themanipulation of one rate? In 1978, the United States was the netcreditor to the world. Today we're a massive net debtor. In 1978,most interest rates were manipulated by the Fed under a regu-latory regime that went out the window in 1980. The world is sovery different from 1978 that we ought to think about what theFed can do and what it can't do and not ask too much of this bodyof mere mortal men and women.

Thank you.[The prepared statement of Mr. Grant can be found on page 90

of the appendix.]The CHAIRMAN. Thank you, Mr. Grant. I'm going to go, in the in-

terest of reaching people who didn't get reached, right to the gen-tlewoman from New York. Does the gentlewoman have questions,or do you want to defer?

Mrs. MALONEY. Well, I was going to pull a report out of myBlackBerry. Maybe I should defer till I get this report out.

The CHAIRMAN. All right.Mrs. MALONEY. But I'll just say what it is generally. It is a re-

port from the United Nations that rates countries in the Westernindustrialized world, and we are rated very, very low, I think 37th,or 47th. Let me look it up.

The CHAIRMAN. All right.Mrs. MALONEY. But I'll ask one question now. You mentioned

about the dollar and how important that is. Well, could any of theeconomists comment on the dollar and the fact that the last time

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I looked it was 16 silver dollars to the dollar. The euro was much,much higher. The value of the dollar is falling in terms of the glob-al market, and what does that mean for us?

I do want to comment to Mr. Blackwell that I'm very, verypleased that you were appointed to the Federal Reserve. Your voiceis refreshing on the need to make sure that our economy expandsand grows for all of our citizens, and I thank you for that reallyheartfelt testimony that you gave.

But could the panelists comment on the dropping value of thedollar and what that means for our economy and for our people?And also, America doesn't make anything any more. We've lost 22million manufacturing jobs. And when I look around my district, itused to be a manufacturing district, now it's a service district. Canour economy continue providing just services and without reallymaking anything? Thank you all for your testimony, and I thankthe chairman for holding this very important hearing.

Mr. BERNSTEIN. If I may make a response to your question aboutthe dollar, earlier in our discussion, one of the members of the com-mittee mentioned that manufacturers in their district said they,"need help being more competitive." I've heard that myself. I thinkdollar policy actually plays a role therein. If some of the othercountries with whom we compete manipulate their currency so thatthe U.S. dollar stays high relative to the value of their currency,it is much more difficult for our exporters to compete. And this hasbeen occurring with, I think, quite alarming results. We've lost 3million manufacturing jobs since 2000, and the story you told, Rep-resentative, is not at all uncommon, particularly in States in theso-called rust belt.

Manufacturing is an integral part of our economy. The produc-tivity provided by manufacturing—innovation, not to mention thequality jobs, are integral to a powerful, strong, innovative economy.So I think as part of the mandate of this discussion, this committeeneeds to look at dollar policy with that in mind.

Now it sounds bad to think about a weak dollar. Weaknesssounds like something we don't want. And if the dollar is to fall tooquickly, that could be inflationary, as others have mentioned. Butan orderly decline in the dollar and a strong stance against thosewho manipulate their currency to boost their exports and hurt oursshould be well within our mandate.

Ms. BLANK. I'd like to just say something about the loss of manu-facturing jobs as well. I'm from Michigan, so I'm very well awareof some of the concerns here. It's not that we actually make a lotless. We make an amazing amount in this country of real goods,not just services, but we use a lot less labor in it because of therise of productivity. And the result of that has been huge displace-ment of", particularly, middle-aged men who thought they were setfor life in terms of a reasonably well-paying job, and have now lostthose jobs.

We have done very little to cushion those sorts of economicchanges, and the loss of income and the loss of employment that'shappened inside families that have been affected by these manufac-turing shifts. It has really been very devastating in some areas ofthe country. It's time to think seriously about some polices thatdon't permanently cushion these things, but that provide at least

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some safety net that allows people to make transitions in theirlives when they get faced with these types of major economicchanges going on around them.

Mr. BLACKWELL. I also wanted to point out that we consume justas many things as a people that we've ever consumed, but weproduce only about 70 percent of what we consume. The other partis purchased from offshore, and oftentimes and increasingly it'spurchased offshore from American companies operating offshore.

Part of the reduction of employment in manufacturing is not duejust to productivity growth, it's due to the outsourcing and theoffshoring of manufacturing activities in U.S.-based companies.And an increasing, a large portion of that is in China, which is thecountry that is manipulating its exchange rates and is tying the ex-change rates of all Asian competitors above what they would be ifthe market were operating.

I think this is a special area of concern of the Federal Reserve,and they need to be asked serious questions about the strong dollarpolicy that they have supported since 1995. This strong dollar pol-icy is making it more and more difficult to have meaningful, pro-ductive activity here in the United States.

When I mentioned before that we have an unsustainable bor-rowing and unsustainable $3 billion a day to pay for the thingsthat we consume that we don't produce, nobody believes this is sus-tainable. We've got to find a way to produce a competitive U.S.economy that will require a lower dollar.

Mr. GRANT. Since the late 1990's, the price of gold in terms ofdollars has gone up a great deal. Gold is a more or less stablesource of purchasing power. Time was when $295 or so bought anounce. Now it's $670. I don't think the dollar policy we have isstrong, but I think we are hugely vulnerable with regard to the dol-lar.

This is a world of paper currencies, and there is something veryfragile about it. These currencies owe their legitimacy to govern-ments and their quoted value to speculators. Think about it. TheU.S. dollar is the global brand name par excellence—nothing likeit. Which, however, puts us at enormous risk for the portfolio pref-erences of the world at large. You know, we issue six—I don'tknow, 800 billion or so greenbacks a year into the world paymentstream. These dollars are absorbed not by private investors whowant the dollars because they trust them. They are absorbed at themargin, and importantly, by foreign central banks.

And how does a foreign central bank buy a greenback? It createsthe local currency with which to buy it. So what you have been see-ing is the huge creation of currencies by all countries. We sendthem paper, they send us stuff. The way they absorb the paper isby printing RMB, yen, Singapore dollars, and Korean yuan, sothere is a huge outpouring of what on Wall Street is called liquid-ity.

Now liquidity is a word for bank credit. It's a word for elixir. Youknow it's—these currencies are flooding the world, and the UnitedStates position is much different than it was in 1978 when Hum-phrey-Hawkins was enacted. Then we might have been able to ma-nipulate interest rates in order to increase employment. Now we

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are at the mercy, to a great deal, of our holders of dollars abroad.We no longer have the freedom of action that we did.

The CHAIRMAN. The gentleman from Alabama. I'm sorry. Thegentleman from Texas first? I apologize.

Dr. PAUL. Thank you, Mr. Chairman. I have a question relatingto a chart on page 4 of Dr. Bernstein's written statement. I don'tknow if you have that chart, but it's a chart that shows a trackingwith productivity and real compensation, and these two linestracked together up between 1947 and 1971, then all of a suddenthey started to diverge.

The productivity curve goes up where the real compensation flat-tens out, and I think that demonstrates much of what many of ushave already talked about, that there is something unfair going onhere. And yet I don't think we've gotten to the bottom of it to findout what was wrong, why it happened, and what we're going to doabout it, and that is I think very important.

Not only has it happened in wages, but we see a difference in theincome on Wall Street. You know, back in 1971 a certain event oc-curred, and I think it was significant. But at that time, wages, theCEO pay was 30 times the wage, but today if you add up all thebenefits of Wall Street, it's 500 times the wage. And yet there isone firm in Wall Street that passed out bonuses of $16.5 billion, sothere's a certain inequity going on.

In this period of time from 1971 up till now, in 1971 in today'sdollar, the minimum wage was $9.50. Today it's $5.15. So we can'tdeny there's an inequity. But the event that occurred in 1971 wasthe breakdown of the Bretton Woods system. And if you put a charton here with monetary supply increases, it would probably be grow-ing much faster than productivity.

My question is, how willing are you on the panel to identify thisand relate this to a depreciation of the money and it being a mone-tary problem rather than some other condition that we could cor-rect by legislation? Dr. Bernstein?

Mr. BERNSTEIN. Thank you for that very interesting question.And in framing the question, I think you raised most of the an-swers that I personally would sign onto. And by the way, myselfand Lawrence Mishel have written a mind-numbing paper that de-composes the gap between those two lines over that period, and Iwill submit it to your office.

I think that there are a whole set of factors, and as I said, youticked them off. But let me make a point that you didn't quitespeak to as much before I talk to your Bretton Woods point. Thefact is that productivity slowed post-1973. This is well known. Andfamily income growth slowed as well. But right after that chart inmy testimony comes a table which showed that as productivityslowed by a percentage point between the postwar boom and thelatter—the period of the gap, where productivity growth slowed byone point, real median family income growth slowed by over twopoints per year. The problem was not just one of slower growth, butit was also diminished bargaining power, lower minimum wages,and a trading system that, I think, began to tilt against Americanworkers in a way that Ron Blackwell has articulated and Dr. Blankas well.

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This is also the period wherein monetary policy became, I wouldargue, much less concerned with Humphrey-Hawkins type goals offull employment and much more concerned with slaying an infla-tionary threat that has more often than not been a phantom men-ace in terms of the actual pressures on prices.

In terms of Bretton Woods itself, I do think that the time hascome upon us once again to have that kind of arrangement wherecountries get together and agree on how exchange rates ought toflow instead of allowing the kinds of mechanisms that are cur-rently, I think, distorting such flows.

Ms. BLANK. Can I just add one thing to that? One of the strikingaspects of both that chart and other similar charts about what'shappening in the United States is that you don't see these samepatterns to anything like the same extent in other parts of the in-dustrialized world. The European nations have not seen the sort ofexecutive pay rise. Yes, it's gone up, but nothing like the extent it'sgone up in the United States. So there's nothing that's inevitableabout this. It is a function of how our economy and our policies or-ganize themselves, and we could organize ourselves in ways thatwould turn some of these trends around.

Mr. BLACKWELL. I would just say, obviously, our members workand live in the real economy for the most part. We are concernedabout the financial economy and its relationship to the real econ-omy, and the Fed is in the center of that mix.

Clearly, there were very important changes, both in the real andthe financial economy in the mid-1970's, all through the 1970's, in-cluding the breakdown of the Bretton Woods system.

I would suggest to you as something you should follow-up on isa discussion of whether or not in a global economy, we can conductmonetary policy as if we have a closed economy.

In the mid-1980's, when currencies got out of line, then-PresidentReagan was able to convene an accord which brought these ex-change rates back into line and helped coordinate the macro-eco-nomic policies of the leading countries of the world, to producemore rapid growth and more equitably shared growth around theworld.

We have no kind of leadership presently at the internationallevel on that basis, and only the United States can provide it.

Mr. GRANT. When people talk about inflation, they define it, Ithink, arbitrarily and narrowly. Inflation proverbially is too muchmoney chasing too few goods.

I think that, in fact, the thing that money chases varies fromcycle to cycle and from era to era. In the 1970's, it was merchan-dise; more recently, it was financial assets.

For Chairman Bernanke to come before the committee and saythe inflation rate is 2.1 percent; that is the measured rate of infla-tion. Excess of dollars have been chasing something else: stock cer-tificates, bonds, commercial real estate, residential mortgages, andresidential houses until recently.

It seems to me that we are the prisoner of the definition of "infla-tion" that does not always serve us well.

The CHAIRMAN. The gentleman from North Carolina.Mr. WATT. Thank you, Mr. Chairman. I thank the chairman for

a fascinating panel. I have so many questions in so many different

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directions, that I am not sure which one I want to ask, and thatis dangerous. Let me wander here a little bit before I ask anything.

The interplay between Dr. Bernstein's testimony and Mr.Blackwell's testimony about full employment most profoundly hadthis impact on me. I had this deja vu moment about the first Hum-phrey-Hawkins' hearing that I attended in this committee, andChairman Greenspan was testifying.

I had come out of the private sector, not paying any attention tothis interplay between interest rates and full employment and in-flation, and the whole range of things he was talking about.

Unemployment was 6- to 7 percent at that time. Here was a manwho was saying to us that we were very close to full employment.I would have to say I was stunned to have the person who was con-trolling our whole monetary and economic policy in this country tellme that at a time when I observed 15, 16, 18, and 20 percent un-employment in my Congressional district, particularly among Afri-can Americans, that we were at full employment.

A stunning revelation. It is the first time I focused on this con-cept of full employment. Had I not gotten side tracked yesterdayon questions about regulatory stuff, the question I wanted to askMr. Bernanke was how do you define what "full employment" is?

This hearing is actually very helpful in that respect because youall are talking about a different kind of full employment than Ihave heard anybody at the Fed talk about. You are saying that theFed's definition of "full employment" is 5 percent unemployment.

Mr. Blackwell is saying our definition of "full employment"should be every single person who wants a job should have a job.I take it that is what you are saying, Mr. Blackwell?

Mr. BLACKWELL. That does not translate into zero unemploymentrate for reasons I will explain, but it should be much below 5 per-cent a year, certainly.

Mr. WATT. I am going to ask two questions and then I will stop.I will ask the first one to Mr. Blackwell and Dr. Bernstein.

How would you want to define "full employment" in the idealworld? And to Mr. Grant—I am sorry, Dr. Blank, I am not ignoringyou—you talked about this blunt edge tool, the roller, in the paintscenario that the Fed has, just dealing with interest rates. It wasnot clear to me whether you are advocating giving the Fed moretools other than interest rate variations to have impacts, or wheth-er you were advocating that we just pay less attention to the toolthat they have and just disregard what they are saying more.

Let's deal with those two questions, and then I will shut up.Mr. BERNSTEIN. Let me read you a quote from today's Wall

Street Journal: "There is no specific level of employment or unem-ployment that is a trigger for inflation."

That is a quote from Fed Chairman Ben Bernanke. He is clearlysaying he does not know what the full employment/unemploymentrate is, in terms of rate. The 5 percent is the Congressional BudgetOffice's estimate of the NAIRU and one that I am quite critical ofin my paper.

Second, to my knowledge—he said a lot about unemployment.Former Fed Chairman Greenspan never said what he thought thenatural rate of unemployment was either.

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Third, if you look at a graph in my paper, it shows that the bestestimates of today's crack macro-economists are that the NAIRU iscoincident with the average unemployment rate. This, as I describein my paper, is a very poor guidepost.

I am just corroborating your view. For myself, especially giventhe conversation I just had with Representative Paul about thesplit between productivity and wage growth, I would believe thatwe are at full employment when we see the wages of most workersrise not in lock step with productivity, but in a range around thatof productivity growth.

We achieved those conditions in the 1990's, between 1995 and2000, and Dr. Blank's work has been very helpful in this regard aswell.

We saw the wages of workers not at the 90th, 95th, 99th, at the20th percentile, low wage workers, 80 percent, rise in step withproductivity growth for the first time in 30 years.

Did skills all of a sudden fall from Heaven and turn these work-ers into highly skilled, more productive workers? No. The job mar-ket finally tightened up and the benefits of our very impressiveproductivity growth were broadly shared for the first time in dec-ades. That is when I will sign off, when we are there.

Mr. BLACKWELL. I think answering this question of what "fullemployment" is in general and today is a very important thing forthis committee to clarify and to understand the thinking of theFederal Reserve. In my service there, this term very seldom comesup.

I said in my testimony that it is an important value for theAmerican labor movement and, I believe, for the bulk of Americanworkers, that if somebody wants to work, they should have a joband it is the responsibility of the Federal Government to make thatpossible.

At any one point in time, Mr. Watt, people are between jobs,when you ask them—frictional unemployment; it is about 1 percentor so. At any given time, workers do not have jobs, or do not havethe skills for the jobs that do exist—structural unemployment; an-other 1 point or so.

If you have a stated unemployment rate or full employment rateof 5 percent, what is that extra 3 percent of workers out there look-ing for a job every day, and in minority communities, it is doubleor triple that, and they are being told that the government is work-ing to keep them from having a job in the name of fighting infla-tion.

We used to call this tragic situation and these people in thistragic situation "front line inflation fighters." Maybe that is a con-tribution to the national welfare, but it is cruel economic policy anda very inefficient way of enforcing price stability.

The main point in my testimony was to say that today, Hum-phrey-Hawkins was a long time ago, but today, I believe the unem-ployment rate cannot just be as it is in Humphrey-Hawkins, a sin-gle unemployment rate number, like 4 percent.

We have 4.9 percent. In the press, it says we have full employ-ment. We are operating at 1 percentage point lower in terms of theemployment population ratio than we were at the peak of the lastrecovery.

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There are a lot of people who are out of the labor force. ProfessorBlank mentioned this in her testimony.

The third element is this connection, this rupture, between pro-ductivity and wages. A relevant concept of full employment wouldinclude both, all three of those elements.

The CHAIRMAN. Mr. Grant?Mr. GRANT. Mr. Watt, you asked about the Fed's empty toolbox.

The Fed can and does manipulate the interest rate. It has a secondtool which is a soap box on which it is often to be seen.

Proverbially, a regulatory body can fix the price or it can fix thesupply. If the U.S. Department of Agriculture wanted to put cornprices at $1 a bushel instead of much higher where they are in themarket, it would not get much corn. It can pick its poison, supplyor price, and since about 1982, the Fed has picked price.

Today, the Fed's price is on outlier. It is the highest price for in-terest rates on the so-called Treasury yield curve. The Fed is gam-bling that its judgment is better than the collective judgment of themarketplace. It might be.

You ask whether I want more armaments. No. I think the Fedhas enough with one or two.

I think we ought to ask if the Fed really can fix this price anybetter than New York City rent stabilization apparatus could fixthe residential rental structure for New York City.

The CHAIRMAN. I thank you. These are important questions, butplease try to stick to one point. We will not be able to get every-thing in.

I was speculating on the limits of metaphor. I am sometimesmoved to speculate on the limits of metaphor, and I just wonderwhether the market could have painted the Sistine Chapel; I thinkthings are being metaphorically carried too far.

The gentleman from Oklahoma.Mr. LUCAS. Thank you, Mr. Chairman. I could not help but note

that as we start to write a farm bill this year in the U.S. House,the observations about that, and agricultural economics is a fas-cinating part of the science.

Since 1933, we have done an amazing job of priming both sidesof the engine by providing resources to encourage overinvestmenton the production side, to keep food costs down, while at the sametime providing food stamps to enhance consumption of that cheaperfood on the other side.

It is an amazingly successful consumer bill.That said, let's address for a moment the limitations, of course,

of the Fed's ability to effect policy. A number of my colleagues, bothtoday and on a number of occasions, have discussed the inequitiesthat seem to be increasing in our society in salaries, bonuses, andthose kinds of things.

Let me ask this question. Would the Fed's toolbox limited in itsnature, and some of you might say that is a good thing, one of thetraditional ways to address these issues, for the last 100 years, hasbeen a progressive income tax code and our progressive estate taxcode.

Let me ask the panel your perspective on that. Do you supportgoing back to a more aggressive progressive tax code and estate tax

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code, and expand on that for just a moment, if you would, why thatmatters, from your perspective.

Mr. BERNSTEIN. First of all, I apologize to Chairman Frank. Wehave been chomping at the bit to talk about these issues for about10 years. We will try to do our best to keep our answers shorter.

Here is how I would answer that question. First of all, I do sup-port a more progressive tax code. Interestingly, in my last com-ment, I talked about the truly impressive benefits of the full em-ployment period, including accelerated productivity goals.

Remember, we had a productivity regime of 1.5 percent for about25 years, a jump up to 2.5 percent in 1995 to 2000, and even a lit-tle faster in the more recent period.

This occurred in a period where the Federal income tax was moreprogressive than it is now. I very much reject the notion thatchanges to make the tax let's say, more regressive, has somehowboosted growth and gotten us closer to full employment.

To the contrary, the last time I observed full employment waswhen the tax code was more progressive than it is today. I tend tobelieve those two are not nearly as related as they are in the eco-nomic debate.

Secondly, a more progressive tax code, especially at a time likethis, with high incomes rising so quickly, would give us more rev-enue to implement some of the programs Dr. Blank talked about,that I also think are very helpful in this context.

Ms. BLANK. I am a very strong supporter of progressive taxes, aswell as some forms of estate tax. I will give you a slightly more the-oretical response, which goes back to some of my comments on whywe care about rising inequality.

The question is what do we mean by "equal opportunity" in thiscountry, and I think equal opportunity has to mean giving peoplethe base in order for them to achieve to their fullest capacity interms of their own sets of skills and talents. That has to mean goodpublic schools, it has to mean effective healthcare, and a wholerange of things that require the government to be involved at leastin part, in the provision of those services, even if the governmentdoes not do all of it.

That requires a stable tax base. This is needed to provide somere-distribution from those who happen to be advantaged in the par-ticular economy to those who happen to be disadvantaged to createopportunity for the next generation.

I would make that same argument about estate taxes as well.Mr. BLACKWELL. The AFL-CIO and American Labor Movement

are very strong proponents of progressive taxes. We very much re-gret the direction taxes have been pursuing most recently.

The recent cuts in 2001 and 2003 were very disproportionatelydirected towards capital and away from people who work, and to-ward richer families as opposed to poorer families. We would liketo see this remedied.

I also want to say that in terms of inequality, at least 80 percentof the growth of inequality is pre-tax income. It is growing inequal-ity by virtue of the imbalance of power in the labor market. It isjust adding insult to injury when the government weighs in withtaxes that increasingly are disproportionately burdening poor andworking class people.

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It is worth mentioning here, as Mr. Grant has pointed out, thatthe Fed cannot generate full employment by itself. It is going tohave to require the action of fiscal policy by the U.S. Treasury aswell, including their decisions on taxes and spending.

These decisions have to be made in ways that respect the incen-tives in our economy to keep economic growth going, but you alsohave to be mindful of leaning against the wind and producing fullemployment.

Mr. GRANT. Mr. Lucas, I would favor something like the repealof the 16th Amendment, but in any case—

Mr. LUCAS. TO the point, Mr. Grant. Thank you. I yield back, Mr.Chairman.

The CHAIRMAN. I think you might get some screaming aroundhere about a package deal if it would include some kind of alter-ation to the 17th Amendment that the United States Senate putin.

Let me recognize myself. One of the things that concerned meyesterday raised with the Chairman that has been alluded to waswhat seems to me to be a bias—"bias" is a negative word—a strongfocus in the Federal Reserve on inflation to the exclusion of em-ployment.

As I said, it is clear, at least to me, that growth alone does notresolve the problem, but the absence of growth would make justabout everything worse.

Again, there was this sort of disconnect in my mind. The Fed hadthree statements in a row in the monetary report, not just testi-mony.

One, we are now producing below capacity and we will be doingso for some time and we will probably hit capacity after a while.No prediction of going above capacity. Two, inflation is moderatingand the reasons that cause inflation are declining. And, three, amajor concern is an outbreak of inflation.

What it suggests to me is that you could have a situation where,if we reached capacity without any significant increase in inflation,there would be an anticipatory increase in interest rates and adrop downward. There is at least a dual mandate in the Hum-phrey-Hawkins Act for employment and price stability.

I am concerned that there are people in the Fed who do not real-ly accept that or who argue, and I would ask you to address this,who argue yes, they are going to serve employment but the bestway to serve employment is to deal with price stability, that fullemployment, maximum achievable employment, will be an auto-matic or at least a semi-automatic result of price stability.

Let me begin with Dr. Bernstein to comment on that set of con-cerns.

Mr. BERNSTEIN. I can be quite brief. I would refer the chairmanand the committee to the table I produced, which just quite clearlyshows that over a period of 20-plus years, we were 19 percentagepoints below the NAIRU. That is, if the NAIRU is 5 percent andwe are at 4 percent, that gets counted as a negative one.

We were 19 percentage points below the NAIRU compared to aperiod when we were 19 percentage points above this natural rate,and in the former period, inflation grew more slowly, and in thelater period, inflation grew more quickly.

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The CHAIRMAN. I think you said that there are people who saythat the non-accelerating inflation rate of unemployment, theNAIRU, is roughly the unemployment rate.

My recollection from the 1990's was that it was a lagging indi-cator of the unemployment rate, that the people who believed in itstarted out by saying it was 6 percent and then unemployment was5.5 percent, when unemployment dropped to 5 percent, they saidit was 5.5 percent. As the unemployment rate actually dropped,this rate stayed above it.

Mr. BERNSTEIN. Half a point. What the economists who have de-fended this view have done is invent something called the "TVNAIRU," which is not the NAIRU you see on television. It is theTime Varying NAIRU. This led Jamie Galbraith to say not only isit invisible, but it moves.

In the policy agenda that I did not speak to in my testimony, inmy spoken testimony, I argued that there is, of course, a role forthe Federal Reserve, as we have been discussing, i.e., re-balancingthe inflation and unemployment tradeoff.

This committee may choose to take another look at the Hum-phrey-Hawkins Act with an eye toward elevating the goal of fullemployment, the Fed's share, and his or her Humphrey-Hawkins'testimony to this body might be required to explain whether thelabor market is at full employment and if not, what steps will betaken to get there.

The CHAIRMAN. Thank you. Dr. Blank?Ms. BLANK. We all know a variety of historical cases where accel-

erating inflation has been a disaster. It is clearly appropriate forthe Federal Reserve to worry about keeping us out of those sort ofsituations.

The question is, "Where are we right now?" One does not needzero price change to have a stable economy. Small and stable levelsof inflation, particularly in the current financial markets with theway we are able to adjust to those with ARM's and various formsof price adjustment mechanisms seem just fine.

The only reason that I could think of to worry about inflation asa major problem right now is if one believes there is somethinglurking out there that could explode, where we do not know enoughabout what is going to happen.

The obvious example is energy prices. We saw an explosion inenergy prices in the last several years. They have not come downto where they were before. If one believed those prices were goingto go up again dramatically in the next year or so, then I think itwould be appropriate to worry about inflation.

The CHAIRMAN. Even there, with a very significant increase, itdid not trigger any kind of rapid inflation.

Ms. BLANK. That is absolutely correct.Mr. BERNSTEIN. Especially in the core rate.The CHAIRMAN. I would also say that I was struck with Mr.

Bernanke. When I asked him why inflation was explicitly themajor concern, and I thought this was rather odd, he said, "Well,they think we are going to not get above trend, above capacity, andthey think there is an inflation problem, but they think they mightnot be right in what they think."

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You cannot logically say I think, "A", but then I also think, "B",which includes "anti-A." Then you do not think "A." You cannot begiven credit for thinking something and simultaneously thinkingthat you do not really think that. He is too smart a man for thatlogic, so I think it is just an institutional bias.

Mr. Blackwell?Mr. BLACKWELL. I think there is an important lesson in this re-

gard to be learned from Mr. Greenspan. I remember in the mid-1990's when economists were telling him that the NAIRU was 6-to 6.5 percent, and that if unemployment fell below that level, thatthere would be ever escalating inflation, accelerating inflation.

Because he was a practical man who studied the material in de-tail and was not given to obeying rules, NAIRU or otherwise, heallowed the economy to grow faster than that, and unemploymentcame down to 3.9 percent with no increase in inflation, and pro-duced millions of jobs.

The CHAIRMAN. And increases in real wages.Mr. BLACKWELL. That is right.The CHAIRMAN. Thank you. One of the members of the Fed

Board who was the greatest opponent of Mr. Greenspan on that,and who felt there was some kind of automatic trigger, wage infla-tion, and unemployment went down, is also the one who expressedsome consternation about the conclusions of Mr. Grant and thispanel. I suppose it is appropriate to ask Mr. Grant to comment.

Mr. GRANT. I think there is a big semantic problem that is con-cealing a bigger conceptual problem, namely that there is no suchthing as wage inflation. Full employment does not cause inflation.People getting work at good wages does not cause inflation.

Money causes inflation. The Federal Reserve, when it falls intoerror, causes inflation.

They say we are producing below capacity. So we are, but we areconsuming above capacity. What this trade deficit means is that weproduce much less than we consume. The risk we face is not somuch that oil prices will rise or certainly not that wages will rise.

The risk is that this Nirvana in which we find ourselves, inwhich we produce so much less than we consume, and we financethe difference with dollar bills we print, that ends because theylose confidence in the currency. That is the risk.

The CHAIRMAN. Thank you. Mr. Bernanke, to his credit, did ad-dress those who tend to blame wages. I appreciate Mr. Grant's an-swer. He acknowledged that, in fact, if wages rise to productivityat a point when price mark up's are much higher than they havehistorically been with regard to productivity-based labor costs, thenit is not wages that is driving this up, and in fact, it would be aconscious decision, through the use of some maybe excessive mar-ket power to raise prices even higher. I do credit him for that.

Mr. Roskam?Mr. ROSKAM. Thank you, Mr. Chairman. I thank you, witnesses,

for your testimony today.I am still in the "trying to size you up and figure you out" mode.

What I am trying to do is figure out—I have always appreciatedover the years when advocates come in and say, "Look, here is thegood side, here is the bad side, and we are advocating this because

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of this." I have not really heard that holistic approach from you.Maybe it is the time demands that are upon us, and I get that.

It does seem to me that there are some really good things thatare happening in our economy today and your testimony, at leastin terms of what I have heard, has not reflected that.

Let me challenge you with a quote. Then I will be quiet and Iwill listen and you can use the rest of my 5 minutes. You can ei-ther answer the question or duck it.

In the September 4th issue of The American Prospect, a guynamed Stephen Rose wrote an article, "What's Not the Matter WithMiddle Class." A couple of sentences: "What progressive's generallysay about the economy is unrelentingly pessimistic, stagnantwages, rising costs, overwhelming burdens of debt. It is a messagethat does not resonate with the middle class, not only because itis overly negative, but because it simply is flat out wrong.

"Absolute living standards for the middle class have only im-proved, even if relative increases in income do not match the gainsat the top," which is basically the argument that you have beenmaking today.

"It is true that the middle class is shrinking but that is becausemore families are better off. The share of prime age adults inhouseholds with real incomes above $100,000 rose by 13.1 percent-age points from 1979 to 2004."

My dad always used to tell me growing up, he would say, "Peter,we live better than kings did 500 years ago", and I do not thinkthere is any question of that.

In light of that challenge, can you reflect on what you think arethe good things that are happening? If the premise is that it is allpain, death, murder, and sorrow, I do not share the premise.

If the premise is that there are challenges that are out there,great. I get that. I think it is always good to reflect on the successthat we have had, and the success that we have, Mr. Blackwell,that have benefitted your organization and your membership, andthe particular perspectives that you each bring to the table.

Mr. BERNSTEIN. Thank you. That is an important dimension tobring to the discussion. I did start my spoken testimony by citinghow low the unemployment rate is in historical terms and howsolid the macro-economy is.

I think those are facts that we absolutely should take a lot ofcredit for and appreciate.

I think the two sides of the good/bad scenario are probably bothseen in the second graph in my testimony, where I show produc-tivity growth, not just growing, but accelerating. Productivitygrowth accelerated about a point between 1995 and 2000. Soundslike one little percentage point, but it is tremendously important.Then another point or so, although that seems to have trailed off,post-2000. Economists assume that the increase in productivitygrowth automatically translates into a better living standard.

I think what we are trying to say and what we are showing withthis graph is that does not occur, when income inequality createsa wedge between the very impressive macro-economic system thatwe all celebrate, low unemployment rate, and the actual livingstandards of middle income families—you mentioned the work Ste-phen Rose cited.

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In David Brooks' column the other day in the New York Times,he cited that same work saying middle income families of a certainage have an income of $60,000, something like that.

It turns out, I went to the data, and found those families havelost 4 percent, about $3,000, in their real income, between 2000and 2005, when productivity growth was 20 percent.

That just does not seem right. It does not seem just. It does notseem fair. It does not seem like the kind of economy that is reallylinking the good side with the less good side.

If we have overemphasized the latter, I am sorry. That linkageis missing and it is critically important, and full employment ispart of it.

Ms. BLANK. Economists are notoriously cautious and pessimistic.When asked to come and testify about what the problems are inthe U.S. economy, here is what you get.

I absolutely agree with Dr. Bernstein that there are a lot of goodthings about the current aggregate economy. We have high produc-tivity, low inflation, low aggregate unemployment, strong consumerspending, and strong business investment; it is a good outlook.

The issue here really is one of who is sharing in those gains. Ifyou are a college-educated worker, the last 10 years, the last 25years, have been some of the best years in history for more skilledworkers in the United States. Things could not have been muchbetter.

The issue is the very large group in the economy that just arenot experiencing that same degree of growth. It is not tricklingdown, to use a phrase from President Reagan, and I think that issomething that we have to be very concerned about.

Mr. BLACKWELL. I do not want to dodge the question. I startedmy testimony by acknowledging that we have the richest countryin the history of the planet.

We have workers who are the most productive workers in theworld, and they are more productive now than they have ever been.American workers work more hours today than workers in anyother developed country.

Our key strength economically, as many imbalances we have, isour capacity to innovate in this country. In the increasingly globalworld, we are going to have to find a way to tap that and tap ittogether to stay on the leading edge of innovation.

That is not going to come out of labs and classrooms alone. Thatis going to come out of the American workplace. We have to be onthe same page and working for the same cause if that is to happen.

The problems that we have identified are distributional prob-lems, but that is one of the things that is dividing us, where wedo not see a common purpose, as Rebecca Blank said.

We are dividing between the very wealthy and the very poor inthis country. Under that kind of circumstance, we are not going tobe able to tap the enormous resources we have and meet the chal-lenges of an increasingly global world that we live in.

Mr. GRANT. The world is a cornucopia, thanks to the augmenta-tion of the world's supply force, labor force, by all these people whowere previously shut out. The world supply curve has moved down-ward and to the right. It is truly the age of abundance.

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It seems to me at a time like this, you are supposed to ask ques-tions. You are supposed to be worried when things are great. OnWall Street, things are perfect, and yet apparently improving.Never so many lent so much at so little margin of safety as theydo on Wall Street today.

We should save the cheerleading for the bottom. Be bullish at thebottom, and bearish at the top.

The CHAIRMAN. The gentlelady from New York.Mrs. MCCARTHY. Thank you. Thank you for your testimony. I

find it fascinating.One of the things that was not brought up was the alternative

minimum tax and how that is affecting the middle income families.I have always had the curiosity when we see so many lost jobs

and even though unemployment is low, those that have lost jobs inthe past, what kind of jobs are they exactly in today? Are they thesame kind of pay? Are they lower pay?

We just read in the paper the other day that Chrysler is goingto be letting go 13,000 people, 16 percent of their workforce.

I also sit on the Education Committee. We have been looking at,for a number of years now, how do we take these workers who arebasically earning a decent salary and re-train them?

A number of issues that came forward and were put into lawwere that they would get a certain amount of money to go back toschool. Yet, when I saw that amount of money, I am saying howare they supposed to go to school, how are they supposed to paytheir mortgages, how are they supposed to pay their car paymentsand keep going, and that would be it. That would be used insteadof a substitute of unemployment.

I do not see good programs that are forecast out there. It is onething to re-train someone, and then they lose their job 2 or 3 yearsdown the road. I do not think there is a good program out there.

What are we looking for in the future and how are we going tore-train these workforce jobs for those that might be manufacturingjobs, but obviously, we are in that trend of—we are not preparingour people. I think that is one of the big problems.

I will open it up to the panel.The CHAIRMAN. Let's start with Mr. Grant.Mr. GRANT. The answer I was formulating is, it is not my sub-

ject, so I will pass. I am sorry.The CHAIRMAN. Mr. Blackwell?Mr. BLACKWELL. I think it is a very, very important point. We

are in a global economy. The economy is changing. Our competitiveadvantages as a country, as opposed to the companies involved, areour people and the skills they have, and the machinery for givingthem those skills is simply not there, and neither are the resources.

I would suggest to you that if we are going to really make thisan innovation-based economy, we have to make training availableto all workers, incumbent as well as displaced workers. We simplycannot afford not to train people for the highest productive andmost creative job they are willing and able to take.

We will not otherwise be able to pull our weight in the worldeconomy. We are completely supportive of that kind of idea. We re-gret that the discussion in Congress is so much how do we dealwith the people who are the losers, and how do we get them into

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a Wal-Mart greeter job as quick as possible, and not spend anymoney on them, either on unemployment insurance or training.

I suggest that we should be taking the position that whetherthey are an incumbent worker or whether they have been dis-placed, displaced by trade or anything else, they should have an op-portunity to train themselves for the most productive job they arewilling and able to take.

Ms. BLANK. I wish I could be optimistic about re-training, but Ihave to say the evidence that I know suggests that most peopleover the age of 40, and as I look around this room, that is mostof us, do not re-learn new skills very easily, and are not very opti-mistic about going and taking on entirely new jobs and new ca-reers. We absolutely need to provide support for re-training, formobility, for workers who have been displaced, but we have notbeen very successful at that in the past.

We need some demonstration projects, some additional fundingthat would let us test whether there are some better ways to dothis. I cannot be very optimistic about that. I think you have to goback and say what we need to do is to ensure that nobody dropsout of high school; that those who graduate from high school canread, and they can do basic math; and that those who get throughhigh school go on and get some additional higher education of somesort, whether it is an associate's degree or a 4-year college degree.Workers need to be ready for a flexible career that means they areable to shift between industries and between jobs over their life-time, because that is the prospect for most of today's younger work-ers.

Mr. BERNSTEIN. My take on re-training is a bit more optimistic.We do actually know some things that work. The tough news isthat they are pricey. You cannot do effective re-training on thecheap.

My concern when I look at where our fiscal priorities are headingis that we are squeezing that very part of the budget, domestic dis-cretionary spending, where our training dollars are going to haveto come out of, so I think we are going in the wrong direction.

The only other comment I will make is that full employmentitself is associated with more incumbent training by employers oftheir workers and occupational upgrading. That is, when you arein a condition of full employment, labor markets are tight, andthere is not a long line outside of the factory or the firm door.

Employers are more likely to undertake training themselves be-cause they have to. Workers' wages are being bid up, and they needto pay for those higher labor costs with increased efficiency.

We call it a full employment productivity multiplier. I think it isreal and another important dimension of the benefits of full em-ployment.

The CHAIRMAN. Mr. Neugebauer?Mr. NEUGEBAUER. Thank you, Mr. Chairman.I want to go in a little bit of a different direction, because some

of the things that have been said today, I may not necessarilyagree with, but one of the things I think this country was foundedon were principles of liberty, freedom, and opportunity.

And that government, and I have not seen it in the Constitution,was not charged with creating jobs, nor do I think it is a very good

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job creator, but I think government can cause jobs not to be cre-ated.

I think Mr. Blackwell said, and I agreed with him totally, wehave moved into a global economy. What we ought to be doing froma policy standpoint is trying to figure out ways that we can makeAmerica more competitive because to me, that creates more oppor-tunity, and in the more opportunity is opportunities for people tohave better jobs, higher paying jobs.

Two points that I want you to address. One, I question todaywhether monetary policy has any significance in that process.

Two, I think more today if we want to talk about how we makemore opportunity and create more jobs is we talk about the factthat there is kind of a three legged stool that keeps America, Ithink, today not being competitive in a lot of ways.

One of those is our tax structure. We had the second highest cor-porate income tax rate in the world. Secondly, we have a regulatoryenvironment that really strangles those people who are trying tocreate jobs in our country today, and all you have to do is look atthe fact that we have not built a new refinery in this country inover 30 or 40 years.

The third piece of that is this litigation web out there that if acompany is doing well, and they make a little mistake, somebodyis going to entitle themselves by dipping into that corporate treas-ury and redistributing that money.

I think the question to each one of you is, does this monetary dis-cussion about employment, does it have a relevance in a globaleconomy?

Mr. Bernstein?Mr. BERNSTEIN. The financial markets certainly respond to the

slightest blink of an eye of Federal Reserve bankers. Monetary pol-icy means a lot to them.

It is also the case, I think we heard earlier, that the Federal Re-serve does not set the unemployment rate. I think those commentsare accurate in that regard. I think Mr. Grant would agree.

The Federal Reserve does not set the unemployment rate withsome really acute degree of accuracy. They absolutely can, in myview, by ratcheting interest rates up higher than they ought to bekeep that unemployment rate from falling to a level that I thinkis truly beneficial, and when they do that, they squander billionsof dollars about putting it into potential jobs and wellbeing, as wehave all discussed.

I would certainly agree, especially regarding money supply in aglobal economy, that the actions of the Federal Reserve are muchless powerful than they would be if we had anarchy. On the otherhand, they do make a difference.

Ms. BLANK. The economy is not a well-defined system of equa-tions; if you push this button, you know what you are going to getout of the other end. Would that it were, we would all be betteroff in that we could predict better.

What does monetary policy do? Monetary policy creates stabilityin the financial markets, in particular. It does other things as well.It creates trust that the U.S. economy is on an even keel, and whatis happening in financial markets leads to business investment andconsumer behavior in all sorts of important ways.

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Therefore, monetary policy affects long-term economic stabilityand aggregate economic growth. That is very highly important notjust for what happens in business America, but it is highly impor-tant for what happens to the families out there as well.

I think you cannot look at that and say that they are not impor-tant to these sets of issues. Certainly the choices that the FederalReserve makes with regard to inflation versus unemployment, inparticular, can affect the number of jobs that are out there.

Mr. BLACKWELL. I think it is a very important question. Weclearly exist in a global economy. No one has any doubt about that,and no one expects the Federal Government to create jobs. Thevast majority of our jobs are private sector jobs.

The question is, does the Federal Government have any responsi-bility for shaping policies that affect the jobs that are created? Inthat category, I would say emphatically, yes.

The question is, given the global and changing nature of theeconomy, what is the nature of the changes in those policies thatwe ought to address?

By our arguing that full employment needs to be re-established,we are suggesting a very powerful way that we think policy couldaffect the material standards of living that we have been talkingabout here.

Monetary policy, as Mr. Grant has pointed out, only operateswith one instrument. We could talk about other instruments thatit needs to be operating with, in financial markets and internation-ally.

That institution has more significance in terms of the Federalimpact on the economy and the level of job creation and the impor-tant relationship between productivity and wages than any otherpublic institution in the country, and it is accountable to the publicthrough the Congress.

Mr. GRANT. Everyone says the world is a global economy, but Isay it is very global. Let me give you an example of how "very" itis.

In the day, you were a customer of your own nation CentralBank. Today, the national markets are basically without bound-aries, and people can, and massively do, lend and borrow in cur-rencies not their own.

There is an immense trade today in borrowing currencies withlow interest rates and investing the proceeds in assets with muchhigher yields. The yen is the world's favorite currency for bor-rowing.

The Federal Reserve does not set monetary policy for the Japa-nese Central Bank. Nonetheless, people outside Japan can, andmassively do, use the yen as a borrowing source.

The world is positively awash in this elixir called liquidity. TheFed is only one central bank. It is not the institution it was in1978. It is diminished by the idea of globalism.

Where is employment doing well? Wall Street. Why might thatbe? Because people are gaming this system of worldwide cur-rencies. Wall Street has never done better. Job growth is nearly atan all time high, and it is because of the institution of CentralBanks, but not for the reason we think, because people can gamethe system of managed currencies.

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The CHAIRMAN. The gentleman from Massachusetts.Mr. LYNCH. Thank you, Mr. Chairman. First of all, I want to

thank the chairman and the ranking member for holding this hear-ing. One matter of disclosure is that I actually am a member of Mr.Blackwell's union; I pay regular dues.

Mr. Chairman, my voice is gone. I am going to have to come backlater and ask my questions.

The CHAIRMAN. All right. We thought you were doing yourJimmy Durante imitation.

Mr. LYNCH. NO. I sound more like one of the Soprano's, I think.The CHAIRMAN. The gentleman will now be temporarily wounded/

departed. Mr. Scott.Mr. SCOTT. This is a fascinating hearing. Monetary policy and

the state of the economy, while the economy looks good on the sur-face, there are subtle as well as very obvious problems arising,which I certainly believe need to be addressed.

I want to talk about a couple of those and have you respond tothem. The first one is this gap in wealth. I would like to hear eachof your thoughts on the current state of our CEO's of these majorcorporations who are receiving these outlandish pensions, and exor-bitant amounts of salary. They are all fine people. We live in a freecapitalistic system where the forces of supply and demand and afree marketplace determine these things.

The problem is while all this is happening, we have lower- andmiddle-class workers who are just barely struggling to make endsmeet. The ratio has gone from something like in the range of a dif-ferential from 10 to 1 to almost like 200 to 300 times what theworkers make. This has just been extraordinary.

I think we have to take a closer look at what we, as Americans,value in terms of our workers. Those at the top are enjoying theperks of this great wealth, and we can agree that the income gapbetween the wealthiest of Americans and the poorest of Americansis continuing to widen.

When we put that together with the other phenomena that ishappening in our economy as a result of the baby boomers, the en-titlement programs, the Medicare, the Medicaid, Social Security,and demands on our health system, all are increasing because peo-ple are going to be living much longer, 80/90 years old, and somuch of this is a burden on the wage earner. That class is shrink-ing.

I think our only real opportunity to increase that is with an ele-phant in the room dealing with labor and economy that we havenot mentioned, and that is immigration, and how you take these—I see the immigration issue as giving us kind of a windfall to helpus to be able to increase this wage earner group as we go forward.There is no other group that we can really look to.

There are 14 million people here, many of them not buying intothe system. We are not cataloging them, but yet they are benefit-ting from it. That is the area that, I think, we can increase ourwage group, but I think there has to be some imbalance there.

I want to talk about that for a moment. Healthcare, I think Mr.Blackwell talked about—it is almost shameful and insulting, thatin a country as advanced as ours, we have people without healthinsurance.

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I give a health fair in my district every year. In Georgia and inthat Belt, so many people are without healthcare. We can do somuch better than that. I think that is part of the problem there.

The other area is one glaring statistic that I want to present toyou, because it very much concerns me. It is a statistic focusing onAfrican American men. Clearly, almost 30 percent of African Amer-ican men at some point are going to be in jail or in prison. Thereis such a waste there. It is a disturbing number that states thatonly 66 percent of African American men are reporting themselvesat work or looking for work.

Those are three areas I want you to just tag for a moment if youcan. I think it provokes some thought. The status of African Amer-ican men and the peculiar situations they are facing in the market-place, it also dovetails in with this imbalance in our labor force andwith CEO's making so much, and then our challenges forhealthcare.

Mr. BERNSTEIN. Let me try to be brief. I am going to defer theAfrican American men question to Dr. Blank because some recentwork of hers speaks directly to that. In the interest of time, I amgoing to speak about the CEO pay, immigration, and just a wordon healthcare.

In the context of my testimony, I stress the issue of bargainingpower. I think what we have going on right now, as we expressedearlier, very positive aspects of our economy regarding productivitygrowth, the efficiency with which we are changing our economic in-puts into outputs is really quite stellar, and a huge gain.

Given the fact that so many workers lack the bargaining powerthey need to claim their fair share of that growth, it is as if thepie is getting larger, the bakers are doing a great job, but they aregetting smaller slices.

How do you change that? That is what I would like to focus onin talking to a body like this one.

There is a discussion now about something called the Employees'Free Choice Act. This is an act that would level the playing fieldfor union organizing, clearly a bargaining power tool.

We have talked about a higher minimum wage. That is anotherway to re-claim some of that fair share of productivity growth, re-distributing, without, as has been mentioned, killing the goldengoose. Full employment as well.

In the interest of time, I will stop there.Ms. BLANK. Let me say a word about your concerns regarding Af-

rican American men. You are absolutely right. This is the most dis-advantaged group in the labor market, whether you look at skills,wage levels, or labor force participation. This is obviously a reallybig and complex question and it gets into a whole lot of history asto how we got here.

Clearly, one of the biggest issues here are the urban schoolswhere an awful lot of African American children, boys and girls,are coming to some of the worst schools in our country and comingout simply not prepared for the labor market in which they arefinding themselves.

You put on top of that some of the changes in our jail and incar-ceration policies, which as you point out, have removed large num-

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bers of African American young men, put them into prison, andthen put them back into society with no support.

One of my biggest concerns is that after spending 15 years talk-ing about welfare-to-work programs, we really need to spend thenext 15 years talking about jail-to-work programs, about ways tomove men from incarceration back into the community.

Mr. SCOTT. Thank you.Mr. BLACKWELL. Just briefly on CEO pay, it was a 20 times dif-

ferential between CEO's on average and workers in 1980. It is now431 times. The average CEO makes more in the first day of workthan the average worker does all year, and he makes more beforelunch on the first day of work than a minimum wage worker makesall year.

This is a signal point. CEO's are now claiming over 10 percentof all corporate revenue, a point of enormous concern to Americanworkers, not only in equality, but even President Bush mentionedthe lack of relationship of this compensation to performance ofthese companies. He was met by silence on the trading floor inNew York when he raised this point.

This is a matter of corporate governance and corporate reform forwhich there is much, much need here, and which needs some atten-tion on Capitol Hill in the form of hearings.

Why is this happening and what can and should be done aboutit without killing the golden goose.

A quick point on the entitlement question. We spend, as I saidbefore—

Mr. GRANT. AS to CEO's, I am a CEO of a minor corporation andwhat I aspire to is to become the CEO of a major corporation. Ithink this is a matter of taste and of the marketplace. There aresome things for which the government really cannot provide the so-lution, and I think this is one of them.

Mr. SCOTT. Madam Chairwoman, may I just ask if Dr. Blank, inher report—I did not know she had a report on this very perplexingproblem facing African American men and the employment laborforce, could we ask that she get a copy to us?

Ms. BLANK. I do not have a specific report, but I can get someresources to you.

Mr. SCOTT. Thank you.Mrs. MALONEY. [presiding] Mrs. Blackburn.Mrs. BLACKBURN. Thank you, Madam Chairwoman. Thank you

to our witnesses for being here.Mr. Grant, three quick questions for you, and I enjoyed your

comments last night on the economy. We talked a little bit aboutlong-term liabilities for the Federal Government, and of course,GAO is saying that with the entitlement programs that were putin place 40 years ago, the growth of those, that we are looking atthat in the near future consuming as much as 30 percent of theGDP.

If you will very quickly speak to the effect that is going to haveon the economy and then relate that to how it would affect our lowincome workers and the poor.

Mr. GRANT. Mrs. Blackburn, a great question, which I certainlycannot answer.

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As a truism, we are prosperity; we do not pay. The tendency isfor prosperity not to pay. Somehow, society gets richer. Somehow,these overwhelming and menacing liabilities get dealt with. I donot know how we will deal with them. I have confidence that wewill, but I cannot say exactly how. The numbers at the momentlook horrific. Beyond those observations, I am afraid I really cannotcomment.

Mrs. BLACKBURN. Let's talk for just a moment about the taxstructure. You may have already covered this. We know that somany countries are going to a flat tax structure. There is quite abit of conversation around that now.

Mr. Neugebauer talked with you a little bit about competitive-ness and taxes and regulations and the effect that would have onour economic growth.

I would like your input as to what your thought is on what weshould do on a tax structure, if we should follow the other countriesand move to a flat tax structure, move to a different type structurethat is capped?

Mr. GRANT. In principle, I believe that you tax the thing youwant less of and tax more lightly the thing you want more of. Ifwe want more enterprise, it would seem to me that you tax thatless.

For that principle and for the general principle of liberty and forkeeping what one earns, I am favor of flatter and lower taxes.

Mrs. BLACKBURN. Let's talk for just a second about intellectualproperty rights. We have discussed the global economy. I found itquite fascinating that protection of the intellectual property rightshas not come up in any of the discussions and you have not equat-ed the impact of that onto the economy.

Personally, I feel like when we look at a global economy, protec-tion of those rights, fighting against piracy, counterfeiting, is veryimportant to having those domestic jobs, and Dr. Blank was talkingabout jobs and re-training, capturing those jobs that are semi-skilled and higher skilled jobs, keeping them here.

Do any of you have a comment that you would offer on intellec-tual property rights and how you see that affecting our jobs' growthand retention, economic growth?

Ms. BLANK. Other than simply to affirm what you said, this isa very important issue for American business, for us to keep busi-ness competitive, to protect patents and to protect intellectual prop-erty.

Mrs. BLACKBURN. Any additional thoughts? Dr. Grant?Mr. GRANT. I am in the business of producing written matter,

which is easily duplicated. It is one of the abiding problems of thisline of business.

We aggressively defend our copyright, and I can only begin toimagine what it is like to have a global franchise with the globalrisks of piracy and infringement. I cannot imagine a more pressingissue in a time when more and more of what we do is of a servicenature and less and less of the product end.

Mrs. BLACKBURN. Mr. Blackwell?Mr. BLACKWELL. We really strongly support intellectual property

rights protection. We think we need to take piracy out of inter-national commerce.

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We feel just as strongly that we ought to take the oppression ofworkers out of competition among countries, and therefore, that isthe basis on which we argue for the inclusion of worker rights, fun-damental worker rights, in those agreements.

We wish those rights were protected as well as they are in intel-lectual property rights.

Mrs. BLACKBURN. Dr. Bernstein, I had one question for you, if Ihave a couple of minutes left. I have done some reading recentlyon child poverty and the reasons for child poverty, which is a heartbreaker to all of us.

So much of what you see are low levels of parental work andnumbers of single parent homes. Those are two indicators, no mat-ter what you are reading and who it is from, that are always there.

When we talk about public benefits, I would love your input aswe talk about jobs that are not those bottom rung jobs, as we talkabout public benefits, and just a comment from you if they wererestructured to reward work and to reward marriage, what yourfeeling is if that would help reduce those levels of child poverty.

Mr. BERNSTEIN. I am quite clear that the evidence is strong thatprecisely that type of program would go a long way in exactly theright direction. The reason I get there—it is great that we are talk-ing about it in the context of a hearing about full employment.

If you look at the employment rates of single mothers during the1990's, we had welfare reform certainly pushing them into the jobmarket, but we also had the first full employment economy in 30years pulling them in, we had an expansion of the earned incometax, it could mean $4,000 or more to a single mother with two ormore children, as well as a whole set of work supports to help sub-sidize the gap between what that woman earned and what sheneeded to bring her family above poverty.

By the way, I think the poverty line is actually insufficient if weare talking about what these families really need for wellbeing. Ithink that the one two punch of work supports, a subsidized wagethrough the earned income tax credit, which I think is a programthat has wide support in this body, and a full employment economygets us a long way towards the goal.

You mentioned a marriage program. In the interest of time, I amgoing to stop there. Maybe Dr. Blank has also looked at that andwants to speak to that.

Mrs. MALONEY. I would like to hear from Dr. Blank as a recog-nized authority on this subject.

Ms. BLANK. On poverty rates among single mothers, it wentdown from 48 percent to 35 percent over the last 12 years. Muchof that is precisely because of the incentives we put in place tomake work pay, so to speak, through the earned income tax credit,through subsidies to child care, and through some pushes from wel-fare as well, to put people out into work.

The fact that only one-third of single mothers are poor is hardlya cause for a celebration, but things are moving in the right direc-tion.

It is certainly true that all of the research evidence suggests thatchildren are better off growing up with more adults in their life.If those adults are married, that is great. If the dad is not in thehousehold but is involved with the kids, that is good. If the grand-

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parents are involved with the kids, that is good. The more adultsyou can put in a kid's life, the better off you are in terms of helpingthem move forward.

I think we do not have very good policies—we do not know howto do marriage policies very well. We know a lot more about howto create jobs than we know about how to create marriages. Thatis one reason why I tend to focus a lot more on the job side becauseI think we have policy leverage there that is more effective.

Mrs. MALONEY. The gentlewoman's time is up. CongressmanLynch?

Mr. LYNCH. First of all, thank you, Madam Chairwoman. I wantto thank the panelists for helping us out here.

As a matter of full disclosure, I am a former president of the IronWorkers Union in Boston. My monthly dues that I pay everymonth, part of it goes to Mr. Blackwell's union, the AFL-CIO.

The title of this hearing is, "Monetary Policy and the State of theEconomy." I am tempted to ask which one, which economy?

I represent both the City of Boston, which is a major financialservices market as well as healthcare, and I also represent the Cityof Brockton, which is an old shoe manufacturing city, both wonder-ful cities, and I represent about 19 towns, the workers in which areprobably a blend of both economies.

One of the things that troubles me is when some economists, notthe ones here today, but some economists talk about job loss andwage stagnation, like they were talking about the weather, like itis a natural phenomenon that we have nothing to do with or nocontrol over, and that we are in this global economy, so why try?

From where I sit, and what I have seen over the past 5 yearshere in Congress, I think there is a real purposeful dimension anddeliberate effort in some cases to undermine the bargaining powerof workers in this country, both the skilled workers who are whip-sawed by the threat of moving high tech jobs overseas, and also thebifurcation between union jobs versus non-union jobs in this coun-try.

I look at the purposeful efforts by this Administration, the BushAdministration, and their policies. They have led efforts to cutovertime standards for 6 million workers under the Fair LaborStandards Act; the first action by the President after HurricaneKatrina was to cut the prevailing wage in Mississippi and Lou-isiana so workers could work for less. That is what he thought wasthe most important thing to do after Katrina, cut the wages ofworkers in Mississippi and Louisiana. Come on.

The trade policies and tax policies that we have adopted in thiscountry to incentivize companies to move offshore or to ship theirjobs overseas, as the kids say in my neighborhood, "You got to getreal about this stuff."

I am a former worker of the General Motors plant in Fra-mingham, Massachusetts. That plant closed down because of poli-cies that incentivized the practice of General Motors closing downplants in Massachusetts, Michigan, Illinois, and shipping themover the border into Mexico. They did that.

That did not happen in a vacuum. That happened as a result ofpolicies that successor Administrations have adopted and there isa whole framework here of labor policy within the United States

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that is overseen by the Labor Department and the National LaborRelations Board.

People in my district are shocked when I tell them that the mis-sion statement of the Labor Department is to strengthen free col-lective bargaining. They are dumbfounded. They are also shockedto learn that the National Labor Relations Act, which created theNLRB, the Act itself guarantees the employees the right to orga-nize and to collectively bargain.

You would not know that if you simply watched what is goingon at the NLRB, which together with the Labor Department, moreso than the Labor Department, has really adopted an attitude anda position that is hostile to workers' rights.

While I do see the greater dynamic here of forces in the macroand micro economies, there is a definite effort here of this Adminis-tration and some of our departments to beat down the rights ofworkers and of these families to make a decent living in this coun-try.

While I really appreciate the high level and the quality of yourdebate, I have to say there are some real things that we could bedoing here, I think, to empower some of these workers.

Mrs. MALONEY. The gentleman's time has expired. I grant himanother 20 seconds.

Mr. LYNCH. What do you think we could do in this country tostrengthen that? You all mentioned at the beginning of your state-ments this imbalance in bargaining power.

Mrs. MALONEY. Mr. Blackwell, very briefly.Mr. BLACKWELL. Put a meaningful floor underneath wages. The

minimum wage should be one-half of the private sector wage fornon-supervisory workers. Give workers the right to organize unionswhen they so choose.

Very centrally and first, I would suggest that at the center ofthis hearing's purpose, to re-establish full employment as the re-sponsibility and the purpose of government, to maintain tight labormarkets.

With tight labor markets, minimum labor standards and theright to organize will close this gap with productivity and wages.

Mrs. MALONEY. Thank you. Congressman Green?Mr. GREEN. Thank you, Madam Chairwoman. I thank the wit-

nesses. Perhaps I should not say "witnesses," the panelists, forbeing here today. You have really been most edifying.

It may look like a set-up for one labor person to follow another,but I, too, associate myself with labor, having been a dues check-off member; that means you are really involved in the process.

We talked a lot about full employment. I think it is a most im-portant subject, full employment. Some people have some degree ofconsternation or look askance at the term "full employment" be-cause some people can remember a time when folks had full em-ployment but they did not receive the emolument that employmentshould accord.

An extreme example would be slavery. Every African in America,not African Americans, but every African in America had full em-ployment, but they did not get the emolument that employmentshould accord the worker.

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I have coined my own term, fruitful employment. Full employ-ment is great, but I think fruitful employment is better. You canhave full employment, work full time, and still live below the pov-erty line. People do it every day in this country. Say, someone isa full time employee, they get $10,000 plus a year, and they haveone child. The poverty line is $13,000, so they are working fulltime, and still living below the poverty line.

You can have full employment and not be able to afford healthinsurance. You can have full employment and have no retirementbenefits. Full employment is not as significant as fruitful employ-ment, employment that allows one to have the emoluments thatemployment traditionally accords.

I agree that there are some things that can be done, and I thinkthat you are on target when you talk about the restoration of thebalance between industry and labor, and things are out of balance.

They are not out of balance because of the workers. The workershave tried to maintain the balance. Right now, the industry hasthe advantage, and policies have allowed the industry to acquirethe advantage.

Either there has to be a reversal or we have to have some newpolicies. I think we have to index the minimum wage. Minimumwage ought to be indexed. CPI or possibly poverty. No one shouldwork full time and live below the poverty line. Index the minimumwage to poverty. You do not live below the poverty line if you areworking full time.

There has to be some thought of whether the paradigm that wecurrently utilize to deliver healthcare is the best paradigm, becauseright now, the paradigm is to do it through one's place of employ-ment.

Well, we cannot compete in the global marketplace, it seems now,with other world class corporations who do not have to factor thatin when they compete with American corporations.

Is this going to be the most efficacious way to deliver healthcarethrough a paradigm that puts corporate America at a disadvantagein this global economy.

I think we have to give much consideration to what has beensaid about the earned income tax credit and I would like Dr. Blank,if you would, to say a little bit more about the earned income taxcredit.

I am concerned as to whether or not if we expand it, it will, ofcourse, have an impact on the economy, but can we expand it andnot have a negative impact on the economy. That is the argumentthat is always made when you talk about expanding these things.

Finally, I am concerned about living in the richest country in theworld, where 1 out of every 110 persons is a millionaire. The rich-est country in the world where we can spend $269 million not peryear, not per month, not per week, but per day on the war. $269million up from $177 million, because of what we are appro-priating. With that kind of money and these kinds of riches, I amconcerned about—

Mrs. MALONEY. The time of the gentleman has expired. I granthim another 20 seconds.

Mr. GREEN. Thank you. I am just concerned about the hopeindex. How does it impact one level of society to see another level

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of society not sharing the sacrifice. The war is being funded on thebacks of the least, the last, and the lost. What about the hopeindex?

Thank you. Thank you for the additional time.Mrs. MALONEY. Dr. Blank?Ms. BLANK. The earned income tax credit, I think, is one of the

best policies aimed at low-income families in the country today.The reasons that we could expand this without having very nega-tive effects are twofold.

First of all, it is a very well-targeted policy. It is focused on work-ers who have low wages in low-income families. Unlike the min-imum wage, which benefits even those workers, the vast majorityof which actually are teenagers, in middle and upper income fami-lies, the earned income tax credit goes only to low-income families.

Secondly, it has relatively low displacement rates. One of theconcerns about wage subsidies is often that companies pay less, be-cause they basically take the Federal dollars and displace theirwages with Federal wages.

The reason this doesn't happen as much with the earned incometax credit is it is paid through the tax system, not through compa-nies in the way traditional wage subsidies are.

If I am an employer, I do not know if you are getting the earnedincome tax credit or if Jared here is getting it, and therefore, I can-not sort of play games with how much I am paying you. I just donot know who is receiving it and who is not, because I do not knowanything about the rest of your family and your total income cat-egories.

Expanding the earned income tax credit is often viewed as—it isviewed as a very efficient policy that has fewer of these sorts of dis-placement effects than many others.

Mrs. MALONEY. Thank you very much. Congressman Cleaver.Mr. BERNSTEIN. Can I add two sentences to that response?Mrs. MALONEY. Yes.Mr. BERNSTEIN. There are two ideas to expand the earned in-

come tax credit currently being discussed by policymakers.One is to increase the benefits to childless workers and another

is to increase what is called the third tier, to add an extra benefitfor families with three or more workers; right now, it is two ormore. Both of those have been shown to have considerable anti-pov-erty effectiveness.

Mrs. MALONEY. Thank you very much. Congressman Cleaver.Mr. CLEAVER. Thank you, Madam Chairwoman.I have two hopefully quick questions. First of all, I do not know

if any of you are able to do so, but I would like to speak Chinesefor a moment.

As many of you may know, under the current Administration,the U.S. debt to China quadrupled since 2000. In the year 2000,$62 billion in U.S. public debt was held by the People's Republicof China. China's holdings on foreign securities today in terms ofthe securities held by China in the United States exceeds $1 tril-lion.

China just tested some new missile as a demonstration that theyhave arrived militarily. We are having this big debate here onwhether or not we should escalate the fighting in Iraq.

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The truth of the matter is that even though the brave and honor-able men and women who are fighting in Iraq are doing exactlywhat the country has told them, the truth of the matter is thattheir fighting is being financed by China and other foreign coun-tries.

Do you think this is a matter of national security or is it some-thing that we should just push aside because most Americans donot understand the debt even if you tell them that every singleAmerican, including the unemployed, has a portion of the debt—$28,000 today and rising.

The third leading expenditure in the budget that was just sub-mitted by the President is the interest on the debt, and it rises$600,000 a minute.

I do not know if any of you can speak Chinese, but if you can,I would like your response, and I would like to ask one other quickquestion.

Mr. BLACKWELL. I think the issue of the imbalance betweenChina and the United States, in particular, is an enormously im-portant issue for the world economy. It is also perhaps a nationalsecurity concern.

I just wanted to point out one thing that might not be on yourscreen. In order to keep its currency at the current levels, Chinais buying large quantities of mortgage-backed securities, whichkeeps housing prices higher than they otherwise would be. Peopleare pulling equity out of those houses. That is part of what hasbeen driving the economy.

The only thing that has been driving this economy in the pastfew years is expenditures by consumers, which is debt finance, andin part, by the borrowings of the Chinese Bank.

Mr. CLEAVER. What happens if China dumps its diet of dollars?Mr. BLACKWELL. Obviously, that is a catastrophe. No one expects

they will because they would be hurting themselves as well. Thereis this kind of dance.

Can they continue to buy an unlimited quantity of U.S. debt andmanage the risk that represents to their own economy, and whathappens to their economy and the U.S. economy if they decide todiversify.

Mr. GRANT. Mr. Cleaver, in the early going, one of the Congress-men said that you cannot consume and save the same dollar, butin fact, you can, and we do. We buy things from China. That samedollar comes back in the form of a purchase of a Treasury securityor a mortgage-backed security.

We have what they call the exorbitant privilege of issuing thisreserve currency, which has stood us in such great stead, but weare ever at risk of the world changing its mind. It will choose otherassets, other reserve assets.

Yes, it is a clear and present danger to our prosperity. We areconsuming much, much more than we produce.

Mr. CLEAVER. Final question, Madam Chairwoman. I think mycolleague is gone, who raised this issue. If everything is so good inthis country, why is it that for only the second time in the historyof the Republic we have a negative savings rate?

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In most Asian nations, the savings rate is 20 percent and above.I think the savings rate in the United States is like .9, close to afull percent.

We have never had a negative savings rate since the Depression,1932 and 1933, and then we started having a negative savings ratein 2005 and 2006.

If everything is great, why is it that Americans—Mrs. MALONEY. The gentleman's time has expired. I grant him

another 20 seconds.Mr. CLEAVER. Why are Americans spending all they make and

then borrowing to make ends meet? Thank you, Madam Chair-woman.

Mr. BERNSTEIN. Quickly, I think one of the reasons for that dy-namic is because interest rates, up until a while ago, were so low.Then-Chairman Greenspan used to make the point in this veryroom, when we talked about these very imbalances, he would saythat servicing the debt burden does not seem to be any worse nowthan it was in prior years, it is around the average level.

The reason was that even though debt was high, interest rateswere low. Now, interest rates have crept back up, and yesterday,Chairman Bernanke presented a chart on the finance obligationratio, that is how much household income it is taking to pay debt,and that is at historically high ranges now.

I agree with you that this is a worrisome development.Mr. GRANT. One thing to be aware of is that this country's cur-

rent account is mainly trade deficit, almost all of it, but there issomething called the balance on income; how much we earn on ourassets abroad versus how much they earn on their assets here.

For three consecutive quarters, that number has been negative,the first time it has happened. We are now borrowing from theChinese, as it were, to pay the Japanese. It is a very big changein our external financial position.

Ms. BLANK. I do want to say a word about savings. Partly, sav-ings rates are low because we have expanded credit availability,particularly to lower income households. The ability to borrow, forinstance, for housing mortgages, in the subprime market, has ex-panded homeownership by 10 points in this country.

That also increases foreclosure rates, because not everybody issuccessful in the long run at that, and you have to balance outwhat you are getting from this additional credit with the additionalfinancial stresses you are creating on households.

For some people, the expanded ability to borrow has actuallyreally given them a great deal of economic opportunity they did nothave before.

Mrs. MALONEY. I thank the panel. I would now like to recognizethe ranking member, and then I have one final question.

Mr. BACHUS. I would like the panel to comment on portablehealthcare plans or portable retirement plans. Companies used tobe loyal to their employees. Today, there is not that loyalty, andsenority does not count for as much, unfortunately.

Mr. BERNSTEIN. I have been watching the system of employerprovided health and pension unravel at a rate that is becoming abit alarming. I think it is still a bedrock system, and I do not wantto create a sense of hyperbole to my alarm.

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The fact is that employers are shedding these obligations. Wehave seen a large sustained shift from defined benefit pensions todefined contribution pensions. Many folks are lucky if they evenhave that.

The end result is that more risk is placed on workers in termsof essentially shopping for those very necessary parts of a social in-surance system on their own.

There are those who believe that kind of market competition willhelp, and I salute that up to a point.

The fact that the risks have shifted such that individuals arebearing more and more, I think, is a worrisome trend.

Mr. BACHUS. Can you also comment on whether or not you haveproposals or know of proposals that might work. I know Wal-Martrecently proposed that we have a national healthcare insurance. Ofcourse, people wondered if that was because they wanted someoneelse to pick up the tab. At least, they were bringing the issue for-ward and I commend them for that.

As you said, with less union jobs, and less bargaining power,some of these benefits are disappearing.

Mr. BLACKWELL. Portability is good. It is not because jobs arechanging rapidly, but portability cannot be used as a mechanismfor allowing employers to walk away from their obligations underthe system, either for healthcare provisions or for retirement secu-rity.

We can imagine a system, and we were thinking about proposingone, where people who offer a healthcare plan or qualifiedhealthcare plan or qualified retirement security plan can run theirown plan the way they always have.

Employers who do not have such plans would be required to con-tribute a proportion of their payroll into a public system that wouldsupplement a system that we already have and that would providefull portability.

What we are very concerned about is efforts like that of thechairman of Wal-Mart. He says that we need to solve thehealthcare problem, but what he has in mind is off-loading his obli-gations onto some kind of individual mandate onto these veryworking families who do not have the money to pay for it, and theysimply end up in the ranks of the uninsured.

Ms. BLANK. Just a quick comment. There are a variety of port-ability plan options that really are aimed at people who havehealth insurance who move across companies. That is important.

It is equally important to worry about the folks who are at em-ployers who basically do not provide, and cannot provide, health in-surance because they are small employers. For this group, we needto create some sort of risk pooling schemes at the State level thatcan both allow those employers to contribute and, at the sametime, give portability to people who move across industries or whoretire early or whatever. If we could do this, it would be a wonder-ful improvement over the present system.

Mr. BACHUS. Thank you. Dr. Blank, I think you may have beenon television, responding to Chairman Bernanke. I had a questionabout the jobs being created. You all may be aware of his testi-mony.

45

His response was there is an enormous demand for high-skilledworkers and high-paying jobs, and the constraint on highest payingjobs, for example, in manufacturing is not the demand but the sup-ply. Firms cannot find workers of sufficient qualifications in manydifferent areas. There certainly has been job creation at the highlevel as well as throughout the distribution of wages. Is there aproblem with educating Americans for those jobs?

Ms. BLANK. There is a problem with education and skills in thiscountry. We do not have the floor on skills that many other coun-tries do. Students who get the worst education come out of our pub-lic school system with less literacy, less math skills, and less jobpreparation than the bottom end of the skill distribution in a num-ber of our competitor countries.

In the long run, the only way we are really going to increasecompetitiveness and jobs for the entire population, and to ensurelong term full employment, is going to be a strategy of educationin the public school system.

Mr. BLACKWELL. There has been creation of high-skilled jobs, noquestion about it. The question is the proportion between the highskilled jobs, higher paying jobs and the lower paying jobs.

It is often reported, I think, particularly through the channelsthat the Fed hears, they hear from the business community thatwe cannot find workers who have the skills we need at the rateswe are prepared to pay. That is the kind of shortage I think theyare reporting. If there were high wages being offered out there,there would be workers who would respond to those wages.

Mr. BACHUS. One of my frustrations has been—I will just takemy home State of Alabama. Our medical schools graduate abouthalf of the doctors we need. There is a critical need for doctors inrural areas. It is not for want of applicants. I always hear peoplehad a 4.0 on a 4.0 scale or 3.8. There are probably 2,000 qualifiedapplicants each year, and they accept 125.

Dr. Blank, you are from the University of Michigan. Why are theuniversities not recruiting these people? Why aren't the State—there are qualified applicants. In many cases, the education is of-fered in maybe subjects where there are not jobs, in engineeringand subjects where we are constantly told this is why people arecoming overseas; we do not have skilled Americans. What can wedo about that?

Ms. BLANK. I do not have a good answer. I do not know enoughabout the medical school market.

Mrs. MALONEY. We are going to have to wrap this up in a second.Go ahead.

Ms. BLANK. I do not have a good answer. I simply do not knowenough about the specifics of what limits enrollments in medicalschools.

Mr. BACHUS. Even in engineering or other fields?Ms. BLANK. Right. I wish I had an answer for you but I do not.Mrs. MALONEY. Congressman Ellison?Mr. ELLISON. Thank you, Madam Chairwoman.My questions revolve around this issue of bargaining power on

behalf of workers. I have to be in and out, so I hope you have notalready addressed this issue.

46

Could you talk a little bit about what accounts for the diminishedbargaining power of working people vis-a-vis labor unions or evenjust on their own?

Mr. BLACKWELL. I think there are four major areas that I wouldidentify. One is that we have a much more global labor marketthan we had, and this global competition has cost us jobs as firmshave outsourced. Even the jobs that have not been outsourced; wesee that across the bargaining table every day. If you do not paymore for your healthcare, we are going overseas. If you demand awage increase, we are going overseas.

The other thing would be privatization of government servicesand de-regulation of particular industries.

The third thing would be, as Dr. Bernstein has mentioned, thefact that the labor market institutions, like the minimum wage,has been lowered to virtually subpoverty levels, and the lack ofworkers' rights to effectively organize.

One that is right in the center of the meaning of this hearing isthe slack in labor markets. The demand for workers is growingmore slowly in its recovery than it has in any other post-war recov-ery. That creates, as I think Dr. Bernstein again described, whereyou have a long line of people outside the door prepared to takeyour job if you make unofficial demands.

Alan Greenspan, I believe, mentioned this in his hearings duringthe late 1990's. Things have changed. There is a lot of fear amongworking people. That is the reason why they are not willing andable to make stronger demands for improvements in their lives.

Mr. ELLISON. Mr. Blackwell, you mentioned the right to organize.Do you think that if Congress strengthened the right to organize,for example, if there was employer neutrality, binding arbitrationon the first contract, how would that impact labor? How would thatimpact workers' bargaining power?

Mr. BLACKWELL. There are 90 million workers in the UnitedStates today who would be eligible to join unions if they want. Over53 percent of those people say they would join a union tomorrowif they could. The reason they do not is employer interference intheir decisions, and hiring anti-union consulting firms and firingworkers who try to form unions. 31,000 Americans were fired ille-gally from their jobs last year for attempting to form an union.

Mr. ELLISON. Did not the NLRB do something about that?Mr. BLACKWELL. Those were the ones who were found to be ille-

gally fired, but the penalties that are attached to those firings areso minimal that it is considered by business as just a cost of doingbusiness.

All you get if you have a finding on your side is you get the dif-ference between the wages you actually earned and the wages youwould have earned if you had your job. The employer might haveto post something in a lunchroom saying they will not do it again.That is not a meaningful bar from interference in workers' rightsto organize.

Mr. ELLISON. What about this idea of the captive audience? Thisis a practice where employers might just call people into a roomand say hey look, and make comments about the problems withunionization.

How does that practice impact employee bargaining?

47

Mr. BLACKWELL. Obviously, if you are living on property that isthe property of your employer, the employer has the right to takeyou into a private room, and this is very routine, this is a core tac-tic of union avoidance, and they explain, find out the nature of yourconcerns, why you are interested in forming a union, and that isthe occasion where they threaten you with the loss of employmentor where they actually terminate you from employment if they de-cide you are incorrigible on this issue.

That is why we just basically have to take the employer out ofthe decision among workers about whether they are going to joina union or not. This is a question of freedom of association. Thisis not a question of the employer voting on whether they have aunion or not.

Mr. ELLISON. YOU talked about a slack in the labor market.Could you help put some better definition to the term "unemploy-ment?" I think most people think you are unemployed if you wanta job and you do not have one.

I have heard other definitions like these are the people who arestill applying for unemployment benefits, that is how we countthem, and then maybe there are some other people who might stillbe looking, which I think would be a little bit harder to pin a defi-nite number on because you would have to rely on a survey.

I know this is elementary for you. Just for the sake of thisrecord, could you define what "unemployment" means so we canhave a clearer understanding of what we are really talking about?

Mrs. MALONEY. If I could add, Mr. Ellison, your exchange withMr. Blackwell earlier showed why we need to pass the EmploymentFree Choice Act that Senator Kennedy and others have put in.

Mr. ELLISON. Let me agree with the chairwoman on that point.Mr. BLACKWELL. I was suggesting before that we have almost

lost the term "full employment" from our dialogue. I think the im-portance of this hearing is we are re-visiting that concept. I thinkwe need to revise the definition of it. It cannot just be the 4 percentunemployment rate that was stipulated in the Humphrey-HawkinsAct.

It has to look at the employment population ratio, which is stilla full percentage point below what it was in the previous peak. Alot of people that are not even in the labor force, as Dr. Blank hadmentioned.

Also, it has to look at precisely this question of the relationship,is there sufficient tightness in the labor market in order that pro-ductivity and wages are moving together, or at least in the samedirection?

Mrs. MALONEY. Thank you. The time of the gentleman has ex-pired.

The chairwoman recognizes herself briefly. Mr. Blackwell ex-plained earlier that working families are keeping up their standardof living or trying to by working harder, longer, taking multiplejobs, and sending more of their family members to work.

I want to spend a little time talking about what this means. Thisis really having a serious impact on real people whose lives aresimply becoming worse.

It is damaging families in America. The report that I mentionedearlier came out from UNICEF at the United Nations. This report

48

said that American children are worse off by multiple objectivemeasures than children in 21 industrialized countries. We come inlast.

The United States was last in health and safety, very low in edu-cation, and second to last in family and peer relationships and be-havior and risk.

I would like the panel's comments starting with Dr. Blank, whois a recognized expert in this area. This reflects the strains, Iwould say, on working families caused by the gap between produc-tivity and wages. I would say wages are a family value and thisreport certainly shows that.

I read reports all the time. I was absolutely shocked by this re-cent U.N. UNICEF report. I would like to hear briefly from thepanel.

Ms. BLANK. I agree entirely with your concerns. I should notethat if you look at upper income families, you do not see some ofthese same things, if you are looking at educational achievement,at health issues, all the things that the U.N. report looks at, thoseare not problems in upper income families.

The reason the United States ranks low on those statistics is be-cause we have this wide distribution and a much lower bottom endin terms of income and skill levels and health disparities thanother countries with whom we are being compared.

This whole issue of inequality is key to understanding why theUnited States is ranking so low. We simply do not have the samefloor, providing the same protections for our lower skilled or lowwage families as other countries do.

Mr. BERNSTEIN. Let me talk for a second about that from theperspective of middle income families. If you look at married cou-ples with kids over the past 25 years or so, their hours of work,the time that family spends in the paid labor market, is up byabout 500 hours over this time period.

That means typically, working wives are spending more than 3months more in the labor market than they were before. That isnot by any means an automatic bad. Part of that represents oppor-tunities that were not available to women in the past.

The fact is this: If you take wives' earnings out of the equation,this family's income has hardly grown at all. Their income growthhas been a function of working wives going to work and workingmore weeks per year, and more hours per week. That is a verypositive development, but it is also a development that createsstress on middle income families, and a lack of work/family balancethat I think shows up in those types of statistics.

Mr. BLACKWELL. I would only add the disproportionate stress asto the women, who as we know still absorb a disproportionate partof work at home while they enter the labor force to help supporttheir family.

49

Mrs. MALONEY. I want to thank all of my colleagues and the pan-elists and the chairman for putting together an extremely inter-esting hearing.

The Chair notes that some members may have additional ques-tions for this panel, which they may wish to submit in writing.Without objection, the hearing record will remain open for 30 daysfor members to submit written questions to these witnesses and toplace the responses in the record.

This hearing is adjourned. I thank everyone for attending.[Whereupon, at 12:44 p.m., the hearing was adjourned.]

APPENDIX

February 16, 2007

(51)

52

Monetary Policy and the State of the Economy

Testimony before the Committee on Financial Services

U.S. House of Representatives

February 16, 2007

Jared Bernstein

Senior Economist

Economic Policy Institute

Washington, DC

jbemstem@epi.org

53

Introduction

I thank Chairman Frank and members of the committee for the opportunity to testify on

the critical issue of the importance of full employment in today's economy.

In recent months, top policy officials and economic commentators have wondered why

there seems to be more economic anxiety among working Americans than might be

expected given the low unemployment rate and solid macroeconomy. Though the Iraq

war was obviously prominent in voters' minds during the midterm elections, polls

revealed that significant majorities were concerned about policy makers' handling of

economic issues as well as their own economic circumstances.

While some officials remain puzzled by this apparent disconnect between

macroeconomic perfomiance and perceptions of economic well-being, Figure 1 suggests

it should not be such a "head-scratcher." After rising at rates close to that of productivity

over the latter 1990s, the real median wage flattened in real terms, as did the average real

wage of high school and even college-educated workers. Granted, the figure compares

the second half of a recovery (1995-2000) with a period that includes a recession, but

unemployment was below five percent by late 2005, and productivity growth has been

even stronger in the 2000s than in the latter 1990s.

In other words, the productivity/wage gap towards the end of the figure is not wholly a

cyclical phenomenon. Nor can it be explained away, as some have tried to do by citing

the growth of employer-provided fringes. Over the five years of economic recovery—

2001q4-2006q4, real compensation grew at an annual rate of 0.8% while productivity

grew 2.8% per year.2 In fact, as is extremely clear in Figure 2, which plots the long-term

relationship between productivity and the compensation of non-managerial workers, this

1 For example, according to the New York Times exit poll, two-thirds of voters reported that they are eitherjust maintaining their living standards (51 percent) or falling behind (17 percent).

Real compensation is from the Employment Cost Index, and productivity is nonfarm business.

54

gap between growth and living standards of working families has been a prominent and

unsettling feature of the economy over recent decades.3

The Productivity-Pay Gap:Hourly productivity and real wage growth, 1995-2006

1995-2000

^ ^

^ * ^ College (Bachelors) Wage*~-^"^t .± J — * — , . „ , 4

•—" " High School Wage 7~^

Median Wage

2000-06

1995 1996 1997 1999 2000 2001 2002 2003 2004 2005 2006

Source: Mshel et al. 2006, Fig.

3 Wage data in Figure 2 are from the BLS series on average hourly wages of production, non-managerialworkers (about 80% of the workforce). These values are scaled up to include fringes by multiplying themby the ratio of compensation to wages from the NIPA accounts.

55

Productivity and Real Compensation, Non-Managers

-RgalCotnp -»-Productivity Growth}

There are many reasons why this gap has evolved but in this testimony I focus on two

related determinants: the absence of full employment and the loss of worker bargaining

power. The key points are as follows:

The combination of slack labor markets and diminished distribution mechanisms

such as unions, minimum wages, and more balanced trade, has led to a persistent

gap between growth and living standards for many working families.

One reason for this imbalance has been allegiance to a "natural rate" theory of

unemployment. Despite little evidence to support its contemporary use, this

theory has led policy makers to give greater weight to inflation relative to

unemployment concerns, and has thus been partly responsible for years of

unnecessary slack in the job market.

56

The post-1973 growth slowdown does not explain the extent to which middle

incomes have lagged growth. Other factors are in play, including slack job

markets and diminished bargaining power.

During periods of full employment, middle-family wage and income growth has

been much stronger, and inflation has grown no faster than periods of slack job

markets.

Economic elites have been operating from a playbook with an inherent bias

against broadly shared prosperity. There is, at this point in time, no legitimate

macroeconomic rationale for this bias, and I urge policy makers to chart the

course back to a policy set that restores full employment, worker bargaining

power, and much more equitable outcomes.

The Evolution of Natural Rate Theory and Its Impact on Working Bargaining Clout

Any discussion of full employment must deal with the concept of the NAIRU, the non-

accelerating inflationary rate of unemployment. For the purposes of this panel, the

important point is that the NAIRU model generates the "natural rate of unemployment,"

the rate below which inflation would not merely rise, it would continuously accelerate

until unemployment went back up to the so-called natural rate. The Congressional

Budget Office currently estimates this rate to be five percent.

Its relevance to our discussion today is clear. If this concept is wrong in that it fails to

accurately describe the relationships between these key variables, using the NAIRU to set

monetary policy could lead to unnecessary slack in the job market, which is particularly

devastating to the least fortunate and demonstrably harmful, as I show below, to the

income growth of middle-income households as well. Similarly, if the concept is right

but we cannot accurately estimate the correct value—the unemployment 'floor,' as it

were—we also risk the danger of erring on one side or the other.

57

Like many economists today, I consider the NAIRU to be a poor guidepost for policy

makers.4 Events have overtaken the original model, and while some useful advances

have been made (Ball and Moffitt, 2001), the evidence I present below suggests that

subscribing to the model risks persistent and unnecessary slack in the economy, wasting

billions of dollars and consigning millions of potential workers to fewer job opportunities

and lower wages than should be the case.

In brief, and simplifying considerably, the original NAIRU story was based on the idea

that the unemployment rate is usually at equilibrium, i.e., just where it should be in terms

of supply, demand, and stable prices. Those unemployed at this "natural rate" can't find

work at the wage they think they deserve, but that's because they have an upwardly

skewed view of their worth (or marginal product). However, the monetary or fiscal

policy authorities want to lower the unemployment rate, and get these folks a job, so they

undertake stimulative actions (lower interest rates, tax cuts, etc.).

Wage offers do rise, and these formerly jobless workers leave the sidelines and join the

job market. However, firms offset their now higher labor costs by raising prices. Soon,

the new workers recognize that they've been tricked: their reservation wage, though

finally met, is not going as far as they think it should. They then demand yet higher

wages—and this is a key piece of the theory that I critique in a moment—and the

wage/price spiral is underway. The only way to stop it is for unemployment to return to

the natural rate, but by then, the inflationary damage is done.

When this model was developed in the 1960s, it had strong predictive power and seemed

to accurately describe events, particularly in the latter 1970s. But evidence over the past

decade, stemming both from research and real events, suggests that the model no longer

holds and that policy maker's allegiance to it has done more harm than good—in my

view, a lot more.

4 International Economist, Benefits of Full Employment, Chapter 2.

58

Most recently, the NAIRU took a beating in the latter 1990s, a period of great relevance

to my testimony regarding the benefits of full employment. At that time, economists

believed that full employment was consistent with an unemployment rate of six percent,

so when the jobless rate began to fall well below this alleged natural rate, the NAIRU-ites

expected inflation to accelerate, especially given the increase in real wages. To the

contrary, inflation decelerated.

Undaunted, NAIRU devotees made two adjustments. First, they allowed that because of

changes in the economy and workforce, the value of the natural rate varied over time.

This led to estimates like those in Figure 3, created by top macro-economists in a 2001

publication.5 The figure shows that the TV (time-varying) NAIRU is just about the same

as (is statistically indistinguishable from) the unemployment rate. If this is true, then we

can't know the NAIRU in real time (since the trend will be changing in unknowable

directions in real time) and the concept becomes a very weak guidepost. As Leone noted,

"If the 'time-variant NAIRU' looks to all the world like a smoothed version of the actual

unemployment rate...then policymaking based on the NAIRU comes perilously close to a

formalized version of the simple rule of thumb: 'keep the unemployment rate near its

average of recent quarters.'"6

s Staiger, Stock, and Watson (2001).5 Richard Leone, in foreword to Krueger and Solow, 2001.

59

Unemployment rate and NAIRU, 1960-2000

Unemployment rate

0.01960Q1 1965Q1 1970 Q1 1976Q1

Source: Staiger, Stock, and Watson, 2001

1980 Q1 19B5 Q1 1990 Q1 1995 Q1 2000 Q1

Second, economists began to add productivity growth to the model, a variable that was

not in the original formulation. This has turned out to be an important development

indeed. Alan Greenspan, for example, appears to have recognized that with productivity

accelerating in the latter 1990s, higher labor costs could be non-inflationary, as they were

offset by steady unit labor costs. This makes sense: firms in the latter 1990s generally

kept their profit margins intact, and paid higher wages out of more efficient production,

obviating any pass-through to prices.

It makes sense, but it's not a NAIRU model, and this is part of my message. It is not at

all clear that the Federal Reserve is operating from this model. The unemployment rate

has been well below the CBO NAIRU, yet the Fed is into a sustained pause regarding

interest rates and inflation appears to be decelerating. While concerns about tight job

markets generating wage-push inflation are of course evident in their statements and

speeches, the actions of neither the Greenspan (in the second half of the 1990s) nor the

Bernanke Fed appear to be dominated by concerns about the natural rate.

60

I believe one reason for this is the diminished bargaining power of the American worker.

Over the post-1979 period when inequality and wage stagnation were most pronounced,

unionization rates fell by half, from about 25 to 13 percent. The real value of the

minimum wage fell to its lowest level in 50 years. Trade penetration has climbed steadily

(exports plus imports are up from about 19% to 28% of GDP since 1979) and our

international indebtedness has grown to historically unprecedented levels, as

globalization and offshoring increasingly put U.S. workers in competition with workers

around the world.

With significantly diminished bargaining power, the NAIRU story falls apart.

Unemployment is not voluntary, and workers can't push for ever higher wages.

Econometricians can make these models fit by allowing them to move with trend

unemployment or productivity growth, but these changes violate the basic premise of the

model, which is based on workers' behavior and expectations, and these behaviors have

changed in ways that render the model ineffective.

The structure of the economy has changed significantly over the past few decades, and

these changes have had a major impact on the distribution of power, and thus the

distribution of economic rewards. Simply put, in a labor market that lacks the institutions

and norms that provide workers with some bargaining power, in an economy where those

whose access to power and assets gives them a huge upper hand in the distribution of

wealth, the predictable outcome is precisely the surge in inequality we have seen over the

past few decades.

In this context, full employment partially takes the place of those institutions and norms

that previously ensured a more equitable distribution of growth. It is one of the few

reliable sources of bargaining power available to the American worker today.

Full Employment, the Natural Rate, Inflation, and Median Family Income Growth: A

Long-Term Perspective

61

With the caveat that I'm reducing many big and complicated changes over many years

into a few key variables, the following two tables make an important and compelling case

for a new economic policy that gives great prominence to concerns regarding bargaining

power, full employment, and inequality.

The first table shows the annual growth rates in the real income of the median family,

productivity growth (the source of improved living standards), and average

unemployment, a rough proxy for full employment/bargaining power. Obviously, big

changes occurred in our economy over these long periods. Changes in family and labor

force composition, family labor supply, immigration, technology, trading regimes, and

much else are embedded in these trends.

In the first period, real median income and productivity grew at about the same rate,

while average unemployment was 4.8%. In the second period, median income grew

much more slowly, and the average unemployment rate was considerably higher: 6.3%.

The lack of income growth over this second period is typically ascribed to the slowdown

in overall growth—shown in the table as a point less per year of productivity growth

(1.8% vs. 2.8%).

But these data show that it is not correct to stop with the insight that both the economy

and income grew more slowly, post 1973. The deceleration in middle-class income

growth, shown in the bottom line of the table, was much greater than the slowdown in

productivity growth. Note also that this income slowdown occurred despite the large

increase in women's labor supply; Mishel et al (2006, Table 1.24) show that among

middle-income families with children, 1979-2000, working wives added over 500 hours,

the equivalent of over three months of full-time work in the paid labor market.

In other words, along with the productivity slowdown, the list of bargaining-power-

reduction factors noted above came into play, and what growth there was flowed less to

the broad majority of working families. At the same time, unemployment was 1.5 points

higher on average. The fact that there was less growth to go around is only part of the

10

62

story. Because of shifting bargaining power and the loss of full employment conditions,

middle-income families worked harder but gained less.

Middle-class income, productivity, and unemployment: two

regimes

Annual Growth Rates

Average

Real Median Family Income Productivity Growth Unemployment

1948-

1973 3.0% 2.8% 4.8%

1973-

2005 0.6% 1.8% 6.3%

Difference -2.4% -0.9% 1.5%

Sources: Census and BLS. Productivity is for nonfarm business sector.

Again, these outcomes have many determinants, but one is the shift away from a

macroeconomics based on full employment to a microeconomics based on managing

individual incentives and expectations. Moreover, despite statistics like those above, the

consensus view among economists and policy elites is that the policy shift has been a

smashing success. Paul Krugman, in a recent essay on Milton Friedman, a founder of the

natural rate theory, made this same point: ".. .given the common assumption that the turn

toward free-market policies did great things for the US economy and the living standards

of ordinary Americans, it's striking how little support one can find for that proposition in

the data."7

A final table, similar to the one above, adds a NAIRU analysis to the picture. Using CBO

historical estimates of the NAIRU, we can determine when the actual unemployment rate

was above or below the "natural rate." The first column of the table accumulates the

annual percentage-point differences over the two time periods. Thus, if CBO's NAIRU

7 See Krugman, http://www.nvbooks.coin/articies/I98S7.

11

63

was 5% and the actual jobless rate was 4.5%, this would show up as a -0.5 percentage

point in our analysis.

Over the period when middle-incomes tracked productivity, the unemployment rate was

often below the NAIRU, cumulatively 19 percentage points below over the years 1949-

73. This happens to be about the same number of points that unemployment was above

the NAIRU in the latter period. Not only was middle-income growth much higher in the

period when we were often below the NAIRU, but inflation was lower as well (and note

that the latter-year inflation comparison leaves out the years of very high inflation in the

early 1980s to avoid an upward bias; nor do I adjust latter period income growth for

families' additional hours of work).8

Clearly, from the perspective of middle-class incomes, tight labor markets, even below

the supposed natural rate, were associated with much better income growth. As these

numbers suggest, the concept of the natural rate has not been helpful to the median

family.

NAIRU Divergence, Family Income, Unemployment,

and Inflation, 1949-2006

1949-73

1973-

2006

Cumulative

Points

Diverging

From NAIRU

-19.4

18.8

Real MedianFamily

Income

(annual

growth)

3.2%

0.6%

Average

Unemployment

4.8%

6.2%

Inflation*

2.4%

3.7%

* Post-73 comparison leaves out 1979-82 to avoid upward bias. Including

these years gives an average of 4.3%.

8 Core inflation follows a similar pattern, 2.9% in period one vs. 4% in period two, also omitting 79-82from period two. BLS core inflation data begin in 1958, so period one goes from 1958-73 is thiscomparison.

12

64

Sources: CBO NAIRU estimates; Census Bureau, median family income (RS deflator);

BLS, unemployment; BLS, CPI-RS deflator.

Conclusion9

The data in the table above cover many years and many regimes, leading some, no doubt,

to discount their relevance. But consider that over the current business cycle,

productivity growth has been stellar, growing once again at an annual rate of 3% (2000-

06), while real median family income is down 0.5% per year (2000-05, most recent data).

And look back at Figure 1 for a graphic depiction of a recovery that, at least from the

perspective of middle-income workers, has been productivity rich but income poor.

I believe a reason for this productivity/income gap is that policy makers, led by

neoclassical economics, have abandoned the two main goals of the economics of an

earlier era: (1) ensuring that we as a society tap our collective potential and fully employ

our economic resources, especially people, and (2) providing individuals with ample

protections and publicly provided insurance against undesirable market outcomes—weak

job creation, high unemployment, rising poverty rates, falling real incomes—and other

challenges like aging out of the workforce or becoming disabled.

This policy regime has been replaced by one devoted to: (1) getting rid of the policy set

associated with the old economics and (2) making sure that individuals are offered the

optimal incentives, the ones that should lead them to behave in ways that, according to

the models, bring about the most efficient results.

In other words, the target of economic policy has shifted away from maximizing society's

potential through promoting full employment and insurance against market failures, and

towards incentivizing the individual's interactions with the market.

' Some of the material in this section is from Bernstein, 2006, Chapter 2.

13

65

Today, we're seeing the results of this shift: greater inequality, a fiscally strapped federal

government, the shifting of risk from the government and the firm to the individual, the

drying up of large risk pools, and the loss of the systems and institutions—like pension

coverage, minimum wages, overtime rules, and a durable safety net—that smoothed some

of the rough edges of our market economy, without diminishing its growth potential.

Can we, however, realistically take lessons from the past given the myriad changes that

have occurred over the last few decades? As Andy Stern recently pointed out, "We're as

far from FDR as he was from Lincoln, and I doubt he was looking to Honest Abe for

policy guidance."

My colleagues at the Economic Policy Institute and I believe we can construct a policy

architecture that both respects the opportunities and constraints of the modern, global

economy, while lastingly reconnecting the living standards of the median family to the

growth of productivity. Our project, the Agenda for Shared Prosperity, is well underway,

and we encourage committee members to learn more about the ideas that we, along with

some of the most progressive and innovative thinkers in economics today, are

developing.

Along with health and retirement security, fair trade, education and fiscal policy ideas,

we are developing an agenda for rewarding work, and maintaining full employment is at

its heart. This, unsurprisingly, includes a role for the Federal Reserve. This role may

entail rebalancing the inflation/unemployment trade-off with less emphasis on fighting

the phantom menace of wage-push inflation. This committee may choose to take another

look at the Humphey-Hawkins Act with an eye towards elevating the goal of full

employment. The Fed chair, in his or her HH testimony to this body, might be required

to explain whether the labor market is at full employment, and if not, what steps would be

taken to get there.

14

66

For groups that are chronically underemployed—those out of the reach of even tight job

markets—we might want to consider direct job creation. In Savner and Bernstein (2004),

we argued that".. .when labor markets are slack, we create public-service jobs to keep

people gainfully employed, drawing on the successful experience of transitional jobs

programs that have sprung up around the country using public funds to create work for

people struggling to get a foothold in the labor market. Such jobs could meet important

community needs and let people use their newly minted skills. What's more, the message

is clear and consistent with values we all agree with: Everyone who wants to work should

have the chance to do so."1

Of course, given that diminished worker bargaining power is at the heart of

productivity/wage gap, measures that rebalance these dynamics will also facilitate a more

equitable distribution of growth. Measures to level the playing field for union

organizing, like the Employee Free Choice Act, make sense, as does the recent legislation

to raise the Federal minimum wage. EPFs policy project suggests a framework for

pushing back against the downsides of globalization while preserving the gains, including

more aggressive tactics to reverse growing international indebtedness, and getting

Congress back in the business of writing more balanced trade agreements."

Opponents and defenders of the status quo may well argue that such proactive efforts will

distort the invisible hand, lead to spiraling inflation, embolden workers to push for wages

beyond their "marginal product," spook financial markets, and so on. But the historical

evidence undercuts these arguments, showing no discernable utility of the "natural rate"

model in the current context. Moreover, the magnitude of the productivity/wage gap, the

extent of poverty amid plenty, the staggering levels of wealth concentration, the abuse of

executive pay-setting practices, and the depth of economic insecurity among the

American middle class suggest that the status quo is unacceptable. I urge the committee

to consider these and other ideas as you undertake to chart a path back to broadly shared

prosperity.

10 http://www.prosDect.org/web/printfrieBdlv-view. ww?id=8357." See Faux 2007, http://www.sharedprosDeritv.org/bpl79.htmI.

15

67

The author thanks Ross Eisenbrey and James Lin for helpful comments and edits.

Bibliography

Bernstein, Jared. All Together Now: Common Sense for a Fair Economy, San Francisco:Berrett-Koehler Publishers, 2006.

Bernstein, Jared and Dean Baker. The Benefits of Full Employment: When Markets Workfor People. Washington D.C.: The Economic Policy Institute, 2003.

Faux, Jeff. "Globalization that works for working Americans." Economic Policy InstituteAgenda for Shared Prosperity. 11 Jan. 2007. <http://www.sharedprosperitv.org/bp!79.html>.

Krugman, Paul. "Who was Milton Friedman?" The New York Review of Books. 15 Feb2007. <http://www.nybooks.com/articles/19857>.

Leone, Richard. Foreword. The Roaring Nineties: Can Full Employment be Sustained?Alan B. Krueger and Robert M. Solow, ed. New York: The Century FoundationPress, 2002. xi-xiii.

Mishel, Lawrence, Jared Bernstein, and Sylvia Allegretto. The State of WorkingAmerica. Ithaca: Cornell University Press, 2007.

Savner, Steve and Jared Bernstein. "Can Better Skills Meet Better Jobs?" The AmericanProspect. 1 Sept 2004. <http://www.prospect.org/web/printfriendlv-view.ww?id=8357>.

16

68

Testimony of Ron BlackwellChief Economist

American Federation of Labor and Congress of Industrial Organizations(AFL-CIO)

Before theHouse Committee on Financial Services

February 16,2007

The State of the Economy, the State of the Labor MarketAnd the Conduct of Monetary Policy

Thank you, Chairman Frank, and other members of the Committee. I welcome theopportunity to be here today to testify on behalf of the 10 million members of the AFL-CIO and share our views on the state of the economy and labor market and the conduct ofmonetary policy.

I should begin by mentioning that I was recently appointed by the Board of Governors ofthe Federal Reserve to the board of Baltimore Branch of the Richmond Bank. I want tomake it clear that I am speaking here today exclusively as a representative of the AFL-CIO and the views I express do not reflect in any way those of the Richmond FederalReserve or the Board of Governors.

From the perspective of the American labor movement, any reflection on the state of theAmerican economy and labor market must address one simple, but central, question:"Why is it so difficult for so many families to make a living by working in the richestcountry in history?"

The U.S. economy is now producing over $13 trillion a year and, despite a recentslowdown, has been growing at a respectable rate. American workers are the mostproductive workers in the world, and they are more productive today than ever before.Americans work hard and today work more hours, on average, than workers in any otherdeveloped country.

Nevertheless, the vast majority of American working families are struggling to maintaintheir living standards in the face of stagnating wages, rising economic insecurity, erodinghealth care and retirement benefits and mounting debt. At the richest moment in ournation's history, the American Dream is fading for a majority of American workers.

We can, and must, do better. But doing so requires us to fundamentally rethink ourcountry's economic policies. No area of policy is more important than our country'smacroeconomic policy, in general, and monetary policy, in particular. We congratulatethe Committee for holding these hearings and hope that this is the beginning of an on-going review of our country's monetary policy.

69

The Fading American Dream

American workers are suffering a now generation-long stagnation of family income andrising economic insecurity.

Since 1980, labor productivity has increased over 67 percent, but the real median wagehas increased less than nine percent over a quarter century. Real median family incomehas increased a modest 15 percent over this period, but mostly because each job requiresmore hours, each worker is working more jobs and each family is sending more familymembers to work.

Moreover, the volatility of family income — and with it the economic anxiety so manyfeel — has increased sharply over the same period. Jacob Hacker the Yale politicalscientist estimates that the chances of a family suffering a 20 percent or greater decline inincome over a two-year period have doubled since 1980.

Rising health care costs and dwindling retirement assets aggravate the economic anxietyworking families feel. Only half of American families have an employer-providedretirement plan of any sort, and only 20 percent of workers today participate in employerguaranteed "defined benefit" pension plans, down from 40 percent in 1980. Insubstituting "defined-contribution" for defined benefit plans, employers are shifting therisk of retirement onto workers who, for the most part, are ill prepared to carry this risk.

And, as health care costs continue to rise, employers shift more and more of the cost ofhealth care onto the shoulders of their employees. Again, working families withstagnating earnings are in no position to shoulder these costs and the ranks of theuninsured continue to rise. Today over 46 million Americans have no health insurance atall, despite the fact that as a nation we spend more on health care than any country inhistory.

The Ruptured Social Contract

The stagnation of wages has ruptured the crucial relation between wages and productivitythat was the heart of the "social contract" that American business and labor struck in theearly post-World War II period and that provided the foundation for building theAmerican middle class.

When both productivity and wages doubled from 1946-73 - the fastest increase in livingstandards in our history — the incomes of every quintile of Americans rose, and thebottom quintile rose faster that the top. Since 1973, however, as productivity continuedto grow but real wages actually began to fall, family incomes stagnated and inequalitybegan to grow. In the earlier period, we grew together as a nation. For the past 30 years,however, we have been growing apart — economically, socially and politically.

70

Over half of all the gains from increased productivity since 1980 have accrued to the top10 percent of American families, most of it to the top one- percent. Indeed, the incomesof top .01 percent of American families - those earning over six million dollars a year -increased 497 percent over this period.

As a result of this rupture between wages and productivity, an enormous redistribution ofincome - perhaps the largest in our history - has occurred from poor and workingAmericans to the top twenty percent of our families. Today, America has the mostunequal distribution of income and wealth of any developed country in the world. Andincome and wealth are more unequally distributed in America today than at any timesince the 1920s.

Our wealthiest families prosper as never before, but the majority of working families areincreasingly left behind. Working families are struggling to make ends meet onstagnating earnings. They are terrified of what a serious accident or sickness might meanfor their families' economic security. They are anxious about their ability to retire andincreasingly angry about the sheer injustice of our country's growing inequality. Most ofall, they are worried about the future of their children.

There are many contributing causes to the stagnation of wages and the rupture of theproductivity-wage relationship over the past thirty years. Central to them all, I suggest, isa steadily growing imbalance of bargaining power between workers and their employers.The implicit "social contract" that allowed Americans to grow together, and build theAmerican middle class, in the early post-World War II decades rested on a rough balanceof power between workers and their unions on one side and employers on the other.Today, this balance of power has eroded and the social contract with American workersis unraveling.

If we are to rebuild the relationship between productivity and wages and allow workers toshare equitably in the value they help create, we must restore the balance of bargainingpower between workers and their employers. This will require a change in our country'seconomic policies, including our monetary policy.

The Eclipse of Full Employment and the Role of Monetary Policy

In the early post-World War II period, when Americans were growing togethereconomically, the central goal of macro-economic policy was full-employment. With theEmployment Act of 1946, the federal government for the first time assumedresponsibility for assuring that everyone seeking employment would find a job. TheHumphrey-Hawkins Act of 1978 reaffirmed that commitment and mandated the FederalReserve to pursue the dual objectives of full employment and price stability. TheHumphrey-Hawkins Act even stipulated a quantitative goal for full-employment — fourpercent unemployment, three percent for adult workers.

Under these Acts, the federal government actively coordinated fiscal and monetary policyto moderate the business cycle, spur economic growth and achieve full employment

71

while maintaining reasonable price stability. The resulting tight labor markets bolsteredthe bargaining power of workers and allowed workers to share equitably in productivitygains. As long as real wages did not rise faster than productivity, there was no pressureon prices to increase.

All this changed, however, when the Federal Reserve, under the leadership of PaulVolcker and in response to the "stagflation" of the 1970s, moved aggressively to raiseinterest rates and slow the economy. The Fed's action did lower inflation dramatically,but at the cost of the most serious recession since the Great Depression in 1980-81 withenormous losses of employment and output.

Of more lasting consequence, however, the Fed shifted dramatically to emphasize pricestability over full employment in guiding monetary policy. Indeed, a new consensusamong monetary policy makers emerged bolstered by changing intellectual fashionsamong academic economists. This new concensus holds that the non-accelerating rate ofunemployment (NAIRU) is determined exclusively by supply-side factors and, in thelong run, cannot be influenced by the effects of interest rates on demand. According tothe new consensus, monetary policy can only influence inflation.

While this consensus now dominates thinking among Federal Reserve policy makers, it isnevertheless subject to serious questions. The economic theory on which the consensusrests involves a number of arbitrary and unrealistic assumptions and the empiricalestimates of NAIRU generated by the theory have varied widely and unpredictably.Given the very serious implications for monetary policy and the ability of the FederalReserve to contribute to realizing the goal of full employment, the Congress must assessfor itself whether there remains scope for monetary policy to affect employment andoutput as well as inflation.

Although the Fed's Congressionally mandated dual objectives have not changed, theactual course of monetary policy over the past 30 years has come to focus almostexclusively on price stability, at great cost to employment and growth as well thegrowing divide between productivity and wages. The resulting slower growth and slacklabor markets have contributed to the stagnation of wages and growing incomeinequality.

Unfortunately, there is now a growing sentiment among monetary policy makers that theFed should aim to achieve a quantitative target for inflation in the range of 2,0 percentper annum. This raises the important question of whether monetary policy should be"rule based" or "discretionary" and whether an inflation target, implicit or explicit, isconsistent with the congressionally mandated target of 4.0 percent unemployment.

Chairman Greenspan was quite skeptical of inflation targets, or quantitative rules formonetary policy in general. Though he strongly agreed with the focus of monetarypolicy on inflation, Chairman Greenspan practiced a "discretionary" policy guided byindividual judgements concerning changes in underlying economic conditions.

72

An important lesson on the importance of a flexible approach to monetary policy can bedrawn from the experience of the late 1990s. Economists were then estimating a NAIRUin the range of 6.0-6.5 percent and warning that unemployment could not be loweredwithout causing a dangerous acceleration of inflation. Chairman Greenspan, notingimportant changes in economic conditions, allowed the unemployment rate to fall to alow of 3.9 percent in 2000 with no acceleration of inflation at all. This was the last timethe economy approached full employment as well as the last time real wages rose alongwith productivity. This was also the last time we saw a measurable increase in realincomes for the vast majority of working families, especially our poorest families.

How many millions of workers would not have found jobs if Chairman Greenspan hadadhered to the consensus view of the monetary policy in the 1990s? How many billionsof dollars of output and income would never been realized? And, had real wages notincreased in the late 1990s, they would be lower today than they were in 1973 andinequality would be even higher than it is today.

The brief period of near full employment came to an end with the 2001 recession.Though the recession was short and shallow by historical standards, the labor marketrecovery has been the weakest of any recovery since World War II. Only in 2005 didemployment recover its pre-recession levels and only last year did real wages begin toincrease. The unemployment rate has fallen to 4.6 percent, but the importantemployment/population ratio is still a full percentage point below its pre-recession peak.

Despite the slow recovery, productivity growth actually accelerated from its alreadyhealthy pace in the previous five years. Nevertheless, in the context of a very weak labormarket, the growth of real wages slowed sharply and median family incomes declined by2.9 percent, compared to an 11.3 increase in the previous five years. Poverty andinequality grew while the proportions of Americans covered by health insurance andpension coverage both fell.

The experience of the late 1990s speaks clearly for the importance of a flexible monetarypolicy for achieving full employment, helping restore the balance between productivityand wages and allowing workers to benefit from the increased value they help create.

Rather than narrowing the scope of monetary policy concern to price stability, the FederalReserve should broaden the scope of its concern to include not only full employment, butalso helping maintain the crucial relation between productivity and wages.

Full employment requires close coordinate of monetary policy of the of the FederalReserve with the fiscal policy of the U.S. Treasury. And, because we live in anincreasingly global economy, both the Federal Reserve and Treasury must manage theexchange rate to achieve full employment as well. Currency manipulation by themonetary authorities of our trading partners, particularly in Asia, is one of the mostimportant factors behind the loss of 1.3 million good paying manufacturing jobs in theU.S. since 1998 and our unsustainable trade deficit.

73

Conclusion

We must restore foil employment as the foundation of our country's economic policy —both monetary and fiscal - if we are to reconnect productivity and wages and assurebroadly shared economic growth. We must also reconnect our country's economic policywith economic values that resonate powerfully with all Americans. Our policies shouldassure that:

First, anyone who wants to work in America should have a job. We need a renewedcommitment to full employment as the foundation of our country's economic policy toassure rapid growth and broadly shared prosperity. The Congress must recommit itself tothe Humphrey-Hawkins Act and insist on more balance in the Fed's monetary policy asbetween its goals of full employment and price stability.

Second, anyone who works every day (a) should not live in poverty, (b) should haveaccess to quality health care for themselves and their family and (c) should be ableto stop working at some point in their lives and enjoy a secure and dignifiedretirement. A meaningful floor under wages and working conditions is necessary if thelowest paid workers are to share in increased productivity. We must also restoreeconomic security to working families by reforming our health care and retirementsystems.

Third, American workers should enjoy the fundamental freedom to associate withtheir fellow workers and, if they wish, organize unions at their workplace. TheCongress should take immediate action to pass the Employee Free Choice Act to allowworkers the freedom to organize free of employer interference and the fear of job loss.This Act would represent an enormous step toward restoring balance between workersand their employers and helping repair the ruptured productivity-wage relationship.

The American economy is changing rapidly and posing very difficult challenges to theliving standards of America's working families. But I am confidant that workablepolicies that meet these challenges and assure the economic basis for strong and broadlyshared prosperity can emerge from a dialogue involving business, labor and the public atlarge. I commend the Committee for beginning this dialogue.

Thank you again for the opportunity to be with you today and share the views of theAmerican labor movement.

4i4t4i41 illLillllAll

74

Employment, Job Opportunities, and Inequality AmongWorkers in the U.S. Economy

Testimony to theCommittee on Financial Services

United States House of Representatives

February 16, 2007

Rebecca M. BlankGerald R. Ford School of Public Policy

University of Michigan

Rebecca Blank is the Henry Carter Adams Professor of Public Policy and Professor ofEconomics at the University of Michigan. She current serves as the Sanford and JoanWeill Dean of the Gerald R. Ford School of Public Policy, and is co-director of theNational Poverty Center, a research center focused on the causes and consequences ofpoverty. The views expressed in this testimony reflect her opinions and not those of anyof the organizations with which she is affiliated.

75

Chairman Frank, Ranking Member Bachus, and distinguished members of the

Committee, I appreciate the opportunity to appear before you to discuss the state of the

economy and the state of the labor market. I am an economist by background, and have

long been very interested in the interactions between the macroeconomy, economic

policy, and labor market outcomes. I speak here on behalf of myself and not the

organizations with which I am affiliated.

Participation in the labor market is key to economic success in the United States.

At an individual level, jobs and earnings are the primary source of income for most

families; at a macroeconomic level, greater employment raises overall output and

increases economic growth. In this testimony, I plan to focus on the economic

opportunities available to the least-skilled workers in the population, discussing the

extent to which they have been able to find work and earn enough to support themselves

in the U.S. labor market. I will also say a few words about the problem of rising

economic inequality.

It has always been clear that the most important policy to assist less-skilled

workers is a healthy macroeconomy with strong job growth. There has been historically

a strong positive correlation between unemployment rates and poverty rates: When

unemployment rises, so does poverty. In fact, when cash assistance became less

available to single-parent families during the 1990s, the correlation between

unemployment rates and poverty for these families became stronger.1 It is worth noting

' Rebecca M. Blank, "Fighting Poverty: Lessons from Recent U.S. History," Journal of EconomicPerspectives, Vol 14(2): 3-19, Spring 2000, or Robert Haveman and Jonathan Schwabish, "HasMacroeconomic Performance Regained its Antipovcrty Bite?" Contemporary Economic Policy, Vol 19(4):415-427, October 2000.

76

that inflation has little correlation with poverty." For non-elderly adults and their children

at the bottom of the income distribution, keeping employment high is significantly more

important than keeping inflation low.

Trends in Unemployment and Labor Force Participation over the Past 25 Years

A primary reason why unemployment and poverty are strongly correlated is that

unemployment tends to be concentrated among less-skilled and lower-wage workers.

Figure 1 shows the trends over the last 25 years of unemployment rates by skill level,

distinguishing between four groups of workers: those with less than a high school degree,

those with only a high school degree, those with some post-high school training but not a

four-year college degree, and those with a four-year college degree or more.

Figure 1Unemployment Rates by Skill Level, 1S79-2005

ro High Softool Dipioma

Source Authors' tabulation of Cur jn Survey data. Ouigomg Rotaiion Groups Ages 18-65

Three immediate facts are clear from Figure 1:

1 Op. cit.

77

• Unemployment rates are substantially higher among less-skilled rather than more-

skilled workers. The brunt of unemployment at any point in time is borne by

lower-wage workers. For instance, in January 2007, over 55% of those

unemployed were low-skilled (with only a high school degree or less), although

less than 40% of the labor force was in the low-skill category.

• Unemployment among less-skilled workers is much more cyclical than among

more-skilled workers. When jobs become scarce, those who lose their jobs first

tend to be the temporarily employed, the part-time employed, or those employed

in less stable jobs and industries. This is disproportionately lower wage and less

skilled workers. Hence, unemployment among the less skilled rises rapidly in

economic slowdowns.3

• While overall unemployment rates remain quite low, unemployment among less-

skilled workers is still relatively high. The ratio of unemployment among less-

skilled (high school degree or less) to more-skilled (more than a high school

degree) workers is higher now than in the late 1990s. The current economic

expansion has not increased employment as much for less-skilled workers as did

the amazingly strong economic expansion of the 1990s.

Of course, the unemployment rate is not a complete indicator of the job

opportunities available (or not available) to workers. In times of higher unemployment,

many workers, particularly women, tend to drop out of the labor market all together,

which means they are not counted in the unemployment statistics. As a result, we often

' For more extensive information on the relatively greater responsiveness of less-skilled and moredisadvantaged workers to the economic cycle, see Hillary W. Hoynes, "The Employment, Earnings, andIncome of Less-Skilled Workers Over the Business Cycle," in Finding Jobs: Work and Welfare Reform,David Card and Rebecca M. Blank, editors, New York: Russell Sage Foundation, 2000.

78

look at overall labor force participation rates — the share of adults who are working or

seeking work (that is, unemployed) - as a measure of the job opportunities available.

More people are drawn into the labor market in a strong economy.

Figure 2 plots labor force participation rates over the past 25 years among more

skilled and less-skilled men and women between the ages of 18 and 65, again

distinguishing between those with a high school degree or less and those with more than

a high school degree.

Figure 2tabor Force Participation Rates by Gender and Skill Level

100%

30%

i: Authors' tabuialron of Current Population Survey data. Outgoing Roialtort Groups. Ages 18-65.

Figure 2 shows two important trends:

Labor force involvement is falling among less-skilled men, relative to more-

skilled men. Surprisingly, this decline in work involvement continued even

through the booming economy of the 1990s and has surely continued during the

2000s. This trend is particularly striking among African American men. Among

less-skilled adult black men, only 66% report themselves at work or looking for

work in 2005.

79

• In contrast to less skilled men, labor force participation of less skilled women has

been rising rapidly over the past decade. This has been linked with welfare

reform efforts and other policy changes (such as the expansion of the Earned

Income Tax Credit) that pushed women off cash assistance and provided greater

incentives for them to work.4

Why Has Work Fallen Among Less-Skilled Men While Rising Among Less-Skilled

Women?

It is important to understand why it is that less-skilled women are working more

while less-skilled men are working less, since this may give us a clue about how to

reverse the decline in labor force participation among men. Part of the answer is policy-

related. As access to cash welfare assistance has become more limited, less-skilled

women (particularly single mothers) are working more. Between 1990 and 2004, the

share of income from cash assistance fell from 23% to 5% among single mothers, while

the share of income from earnings rose from 57% to 66%.3 This helps explain why

women might be working more, but it does not explain why male labor force

participation is falling.

As welfare reform pushed women into the labor market, a number of other

policies that were designed to subsidize work among lower-wage workers have

disproportionately benefited less-skilled women and particularly single mothers. The

large expansions in the Earned Income Tax Credit (EITC), which provides a substantial

A Summaries of this research are provided in Rebecca M. Blank, "Evaluating Welfare Reform in the UnitedStates, Journal of Economic Literature, Vol 40(4): 1105-66, December 2002, and in Jeffrey Grogger andLynn A. Karoly, Welfare Reform: Effects of a Decade of Change, Cambridge: Harvard University Press,2005.! Based on tabulations of Current Population Data.

80

subsidy through the tax system to low-wage workers in low-income families with

children, have been very important in propelling more single mothers into work. Several

researchers suggest the EITC was more important than welfare reform in increasing work

and earnings. Along with welfare reform, both federal and state governments have

significantly increased child care subsidies, making it cheaper for women with children to

work. Finally, changes in public health insurance through Medicaid have also assured

that children (but not their parents) in low-income families are covered by public health

insurance.6 This means that women who leave public assistance to work in low-wage

jobs without health insurance coverage will no longer lose insurance for their children,

and this may also have increased their willingness to work.

In short, the United States implemented a set of policies that subsidized work

and that particularly encouraged former welfare recipients to move into work. The result

was a significant increase in employment among this population. Furthermore, this

increase in employment has lasted through the first decade of the 2000s, despite a ,

somewhat more sluggish labor market. While labor force participation has fallen

somewhat among less-skilled women in recent years, it remains above where it was in the

early 1990s (see Figure 2).

But policy changes are not the only story for understanding differential

male/female changes in employment. Macroeconomic shifts in demand are also very

important. Declining demand for less skilled workers has pulled down wages of both

less-skilled men and women. These declining real wages among men have been directly

correlated with their declining labor force participation. Women's wages were less

affected, however, as other offsetting forces have moderated these demand changes.

6 The two publications referenced in footnote 4 also provide summaries of this research.

81

Figure 3 shows median weekly wage rates among women by skill level for the past 25

years. Wages among less-skilled women have increased over time, particularly since the

mid-1990s. My own calculations of inflation-adjusted median weekly earnings indicate

that women who are high school dropouts have seen their weekly wages rise by 14%

between 1990 and 2005, while women with only a high school degree have seen

increases of 21%.7 These wage increases reflect increased labor market experience

among women (which is correlated with higher wages), increases in the returns to

experience (so that each year of experience results in greater wage growth), and sharp

reductions in the extent to which women with children experience lower wages.8

Figure 3Women's Median Weekly Wage Rates by Skill Level (2005 dollars)

c liege Gra

_ "

Some

uate, Bachelor's

i i

College LESSBacheiDr*s Deg

Degree

- « '

or Higher

Wgr) School Dipia

^ .

"If*^v; ""

No Higtt School Diploma

These wage changes among less-skilled women are in contrast to less-skilled

men. Figure 4 shows the same wage trends among men by skill level over the past 25

These calculations are based on the Outgoing Rotation Group data from the Current Population Surveyfor women ages 18-65. The data are adjusted for hours, to provide a measure of full-time equivalent wages.Inflation adjustments are based on the GDP Personal Consumption Deflator.8 See the article by Rebecca M. Blank and Heidi Shierholz, "Exploring Gender Differences in Employmentand Wage Trends Among Less-Skilled Workers," in Working and Poor: How Economic and PolicyChanges are Affecting Low-Wage Workers, edited by Rebecca M. Blank, Sheldon H. Panziger and RobertF. Schoeni, New York: Russell Sage Foundation, 2006.

82

years. In recent years, from 1990 to 2005, real median weekly earnings among men rose

much less than among women. Among male high school dropouts, wages were virtually

unchanged over this period, rising by 1%, while wages rose by 9% among those with

only a high school degree.

Figure 4Men's Median Weekly Wage Rates by Skill Level (2005 Dollars)

BOO

600

200

College Graduate, Bachelor

Same College, La Bachelor's

s Degree o

Degree

Higher -^

Htgrt Sc

^ ^ — '

oof OipJorrta Oniy

^ No High Scfiooi Diploma

Source. Authors' tabulation of Current PopulationNo!e: Adjusted for fufl lime equivalents; inflation o

ta, Outgoing Rotation Groups Ages 19-65lassa on GDP Personal Consumption Deflator,

Less-skilled men and women have fallen progressively further behind their

more skilled brothers and sisters; completing a high school degree no longer allows

access to jobs that pay middle-income wages. In this sense, the job market has gotten

tougher for both low-skilled men and low-skilled women. But other changes among

women - growing work experience, greater returns to experience, and a reduced trade-off

between children and wages - have offset these problems and led to somewhat greater

wage increases among less-skilled women.

While the evidence suggests that less-skilled women are doing better than

similar men, I do not want to paint a rosy picture of the low-wage labor market for

women. Because women's wages are lower than men's, they often earn very low

83

10

incomes while struggling to meet the demands of their employers, caring for their

children, and organizing child care during work. One group in particular appears to be

struggling the most. A group of highly disadvantaged single mothers seems to be facing

particularly low incomes. This group - often referred to as "disconnected" — is neither

working nor on welfare. Most disturbing, this group has been growing rapidly post-

welfare reform. Currently, 20 to 25% of single mothers report themselves as neither

working nor on welfare, double the number only 10 years ago.9

This group is very poor. Only half of these mothers live with another adult, and

even those who do have low household incomes. Research suggests that this

disconnected group is largely composed of women who have left welfare but who have

multiple disadvantages or barriers to work, including low skills, health problems and

especially problems with depression, responsibility for a child or adult with health

problems, substance abuse problems, and cui'rent or past experience with domestic

violence. The more such "barriers" a women faces in her life, the less likely that she is

able to find and keep a stable job.10

Unfortunately, cash assistance through welfare has become increasingly

unavailable to these women as well. This population is most likely to be either time-

limited from welfare or sanctioned for non-compliance with welfare rules. I am deeply

concerned about this quarter of single-mother families — and their children! — that have

not succeeded in making a stable transition from welfare to work and who are able to

work only sporadically or part-time. This is a group for whom we need to rethink our

9 Rebecca M. Blank, "Improving Che Safety Net for Single Mothers Who Face Serous Barrier to Work,"Future of Children, Vol 17(2), forthcoming Fall 2007.10 Op. cit. See also Lesley J. Turner, Sheldon Danziger and Kristin Seefeidt, "Failing the Transition fromWelfare to Work: Women Chronically Disconnected from Employment and Cash Welfare, " SocialScience Quarterly, Vol 87(2): 227-249, June 2006.

84

II

policies, re-creating a safety net that can help provide economic stability to this group of

women and children.

The Impact of Inequality

It is, of course, worth noting that Figures 3 and 4 indicate strong and continuous

increases in wages among the college educated. The demand for more-educated workers

has grown strongly over the past 25 years, while the demand for less-skilled workers has

not. This rising inequality in wages is reflected in rises in household income inequality

as well, although income inequality has not increased as much as wage inequality. This

is because more adults in poor households are working today than in past decades, hence

increases in hours of work are offsetting relative wage changes."

Rising inequality has been correlated with a variety of economic shifts in the

U.S. economy. Shifts in demand have privileged more-skilled workers, relative to their

less-skilled brothers and sisters. These demand shifts are due to changes in technology

and in the global competition for workers.12 More-educated U.S. workers - and we have

the best group of highly-educated workers in the world - have gained enormously from

the expanding and increasingly interconnected international economy and from the new

technologies in information and communication. Less-educated workers have gained

much less from these changes.

" Sheldon H. Danziger, "Fighting Poverty Revisited," FOCUS, Institute for Research on Poverty,University of Wisconsin-Madison, forthcoming.12 An extended literature discusses these wage trends. A very good recent contribution summarizes thisliterature, David H, Autor, Lawrence F. Katz, and Melissa S. Kearney. "Rising Wage Inequality: The Roleof Composition and Prices.'1 National Bureau of Economic Research Working Paper No. 11628,Cambridge, MA: NBER. September 2005.

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Why should we care about rising inequality? There are at least three reasons.

First, there is a sense of economic deprivation among lower income families, as they

watch others move further ahead. Tuition for higher education is increasing faster than

inflation; housing prices and rents in many areas of the country have increased much

faster than overall prices. Health care is almost impossible to purchase on the open

market, if not provided by one's employer. Lower-wage workers in today's economy

find it hard to achieve those things that are part of the American dream.. .your own house,

a job with pension and health benefits, or the opportunity to send your children to college.

Second, economic inequality is deeply linked with other types of social

inequality. Health disparities between more and less-educated workers have widened

over the past few decades. Differences in educational achievement are widening between

the best and worst students. These social inequalities only reinforce economic inequality.

More troublesome, they may limit opportunities for the children of today's lower wage

workers. Economic mobility has always been an important promise in America. But

widening inequality makes it harder for the children growing up in today's low-income

families to dream about doing better. In fact, quite a bit of evidence now suggests that

economic mobility is greater in many European countries than it is in the United States.13

Third, economic inequality and a sense of relative deprivation can have

negative effects on the civic and the political realm. The economic experiences of the

past two decades are very different for those with a college education than for those with

only a high school education. This makes it hard to engage in a common conversation

about economic problems and their solutions. Fear of technological change and of

L' Markus Jantti, et. al., "American Exceptional ism in a New Light: A Comparison of IntergenerationalMobility in Nordic Countries, the U.K. and the U.S.," IZA Discussion Paper No 1938, Bonn: 1ZA, 2006.

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growing economic internationalization is fueling a backlash that can lead to bad policies

that limit future economic growth. Public discussions of social security reform or health

insurance reform are hard to hold when the bottom third of the population has only social

security and Medicare to rely on in old age, while the top third has extensive market

investments and long-term supplemental health coverage through their job. In short,

economic inequality makes it harder to solve our common problems and harder to evoke

a sense of common purpose and experience. This is not only inconvenient for politicians;

it can threaten the civic nature of public debate in a democracy.

Inequality is an inherent and necessary part of any market economy, but the

sharp rises in relative well-being between different groups in the current economy is very

troublesome. High and rising levels of inequality are a social and economic problem that

will limit economic and policy progress on many fronts.

Policy Implications

What do we need to be thinking about on the policy front to deal with these

differences in employment and earnings opportunities? I strongly agree with Federal

Reserve Chairman Ben Bernanke, who in a recent speech has called for investments in

education and training to moderate inequality.14 In the long run, more Americans need

more and better education; and as Chairman Bernanke has noted, it might be as important

to expand pre-kindergarten education as to reform high schools. There is increasing

evidence regarding the value of publicly available pre-K programs, for instance.

"* "The Level and Distribution of Fconomic Well-being", speech by Ben S. Bernanke on February 6, 2007.See http://www.federalreserve.gov/BoardDocs/Speeches/2007/20070206/default.htm

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But, by itself, a strategy focusing on educational improvements is not enough to

assure adequate work and income among less-skilled Americans and their families. At

least three other broad policy components are necessary:

(1) We need a strong labor market with growing demand for workers at all

skill levels. Interestingly, some recent research suggests that middle-income workers

may be recently experiencing as many or more limitations in job growth as lower-wage

workers.1' Those of us from Michigan are especially aware of the need to keep our

economic growth strong and our industries competitive. This means macroeconomic

policies that provide stable economic growth and low unemployment for all workers.

(2) We need to maintain and expand our policies that subsidize work for the

least skilled and thai encourage adults to take and keep jobs. It is an unfortunate fact that

employment may not lead to economic self-sufficiency among today's low-wage workers.

As their wages have grown more slowly, rising energy prices and rising housing prices

have left less-skilled workers struggling to pay the bills. For the least-skilled workers,

full-time work at or near the minimum wage results in an earnings level that is well

below poverty if they are trying to raise children and support a family.

While I know that this Committee tends to focus on more macroeconomic

policies, a healthy macroeconomy requires attention to specific policies that subsidize

and encourage less-skilled workers to stay in the labor market. We are far better off

keeping less-skilled workers stably employed in mainstream jobs than risking the social

problems that result from lack of jobs or inadequate incomes, including crime,

underground economic activity, lack of residential stability, and a cycle of poverty and

15 David H. Autor, Lawrence F. KaR, and Melissa S. Kearney, "The Polarization of the U.S. Labor Market,American Economic Review, Vol 96(2): 189-194, May 2006.

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low skills that gets passed from one generation to the next. This means maintaining the

EITC and even extending its generosity among less-skilled workers who do not have

younger children to support. It means a moderate minimum wage, set at levels similar to

where it has historically been set. It means assuring that low income families have health

care available to them, so that illness doesn't mean economic disaster from either loss of

employment or unpayable medical bills. It means that Unemployment Insurance should

be available to workers who lose their jobs, even if those jobs were part-time or low-

wage.

(3) It is important to think creatively about ways to make sure that all

Americans benefit from the economic growth caused by recent economic shifts. The

economic changes of the past 25 years have not been good for less-skilled workers.

Perhaps these problems were neither preventable nor foreseeable. As an economist, I

believe in the value of global markets and world trade for U.S. economic growth, just as I

believe in the value of inventing and applying new technologies to increase productivity.

These changes have provided enormous advantages to college-educated American

workers. But they have disadvantaged less-skilled workers.

There are two ways to distribute the benefits of these changes more broadly.

First, we can redistribute some of the gains through the tax and transfer system. This is

exactly what an expanded EITC or better health care coverage provides. Second, we can

assist those workers who are displaced by new technologies or by shifts in where goods

and services are produced. A policy such as wage insurance, aimed at cushioning

income losses for displaced workers, can help America's workers adjust to a changing

economy.

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Work is a good thing in the lives of adults. It produces income, but it also

provides a sense of self-value by demonstrating that an individual has skills to contribute

that the economy values. We should do all we can to encourage men and women to

acquire the skills and work behaviors that allow them to support themselves and their

children. But we should also do all we can to guarantee that there are jobs available to

those who want to work, and to ensure those who demonstrate their ability and

willingness to work are able to support themselves and their families.

Thank you.

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House Committee on Financial Services

Hearing on monetary policy

February 16,2007

James Grantwritten statement

The Federal Reserve figuratively prints the thing we all want more of. Why solittle of this manna seems to find its way into deserving pockets is at the top of today'sagenda.

Under the law, the Fed has a dual mandate. It must protect against inflation, asdefined, and promote full employment. But Congress and the American people havecome to expect much more from our central bank than even that tall order. We ask, inaddition, that it make an inherently risky world safe. We expect the Fed to deliver usfrom the consequences of hedge-fund explosions, sovereign-debt defaults, bear stockmarkets, bank failures, deflations and other financial and economic vicissitudes.

It can't be done. Goldman Sachs itself would blanch at the task. It's not that lowinflation and high levels of employment are incompatible. They are not, I believe. Theexperience of the past 50 years assigns a pretty heavy burden of proof to any exponent ofthe so-called Phillips curve in any of its many guises. A little more inflation may bringforth (for a while) a little more employment. Much more dependably, a little inflation willdeliver a little more inflation, and then a little more, and so forth, followed by much lessemployment.

The trouble with the Fed's mandate boils down to two obstinate facts. The firstconcerns inflation itself. It is not easy to define, let alone to control. "Too much moneychasing too few goods" is familiar but incomplete. "Too much money, period," is better,though admittedly vague. What the money chases varies from era to era. In the 1970s, itwas goods and services. More recently, it was houses (and office buildings and highlyleveraged corporations, among other investment assets). The fact that we called thislevitation of house prices something besides inflation does not alter the fact that amonetary disturbance changed the way millions of Americans lived and worked. Onceupon a time, former chairman Alan Greenspan defined inflation as a change in pricessufficient to cause people to adjust their behavior. The house price bubble exactlyconforms to that definition. It was a kind of inflation.

Obstinate fact No. 2 lies in the way the Fed goes about its work. It fixes aninterest rate. This one and only policy instrument is a very blunt tool. What Pope Julius IIdid not say to Michelangelo was, "Here's your roller. Now go paint the ceiling of theSistine Chapel." It is worse than that with the Fed, however, because a paint roller never

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destroyed an industry or led directly to shortages of New York City apartments ordisintermediated the nation's thrift institutions. So great is the Federal Reserve's prestigethat it is easy to gloss over the essentially disreputable method by which it goes about itsjob. The fact is that the Fed—like the unreformed Texas Railroad Commission, the NewYork City rent-stabilization apparatus and the late, unlamented Interstate CommerceCommission and Civil Aeronautics Board—is in the business of price control.

Now I want to give credit where credit is due. The currency that the Fed sponsorsis passed from hand to hand the world over. It is not the first dominant global monetarybrand—the pound sterling ruled the roost in the 19th century and for a few decades of the20th. But the dollar is the first universally honored irredeemable paper currency. Not since1971 has anything tangible stood behind it. It is uncollateralized—faith-based—yet theworld accepts it. It is America's greatest export. The United States consumes much morethan it produces and discharges its foreign debts in money that it alone is allowed to print.If there were ever a golden age of paper money, this is it.

Perhaps out of respect for these wonderful facts, the financial world hassuspended its disbelief about the Fed's operating method. Ask a Wall Street economist ifthe Department of Agriculture should set soybean prices or the Federal EnergyRegulatory Commission gasoline prices, or whether the Fed itself should get back intothe business of fixing bank deposit rates (as it did from 1933 to 1980), and your answerwould be a disdainful stare. Yet these same believers in the efficacy of price discoveryaccept that the Fed can determine the correct federal funds rate. They go further: Havingdreamt up the right rate, the Fed should impose it on the market.

Of course, people in markets are not infallible. Neither are people inbureaucracies incapable. Markets are not divinely ordered. But market judgments,however imperfect, are generally less imperfect than the decisions decreed from on high.It's true that the Fed does not impose its will without reference to markets. But, havingtaken the markets' pulse, the Fed sometimes decides that it knows better than they do. Itso judged in 2002-03, and it seems to believe it again today. This is very thin ice onwhich the Fed is skating—on which we are all skating, the American wage earner notleast.

The Fed was at its most unilaterally willful four years ago. You may recall thatthe Federal Open Market Committee was agitated about what it chose to call deflation.The stock market bubble had burst, there was a short recession (March-November 2001),the CPI had lost its bounce and employment growth was disappointingly sluggish. Japanhad not yet rubbed the sleep out of its eyes from a decade-long economic hibernation.The risk of falling prices preoccupied our central bank.

The Fed had begun to chop away at its interest rate before the recession officiallybegan. It was hard at it all during 2001. By the time the anti-deflation campaign reachedfull rhetorical strength, the funds rate sat at 1 lA percent, the lowest in decades. But it wasstill too high, the FOMC broadly hinted. Messrs. Bemanke and Greenspan vowed to doeverything in their power to hold the inflation rate to a decent minimum, say 1 Vi percent

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to 2 percent a year. And to what lengths would they go? "[T]he U.S. government has atechnology called a printing press (or, today, its electronic equivalent)," said Mr.Bernanke in November 2002, "that allows it to produce as many U.S. dollars as it wishesat essentially no cost." That left little enough to the imagination. Neither did the remarksof his then boss, Mr. Greenspan, who observed: "The Federal Reserve has authority topurchase Treasury securities of any maturity and indeed already purchases such securitiesas part of its procedures to keep the overnight rate at its desired level. This authoritycould be used to lower interest rates at longer maturities. Such actions have precedent:Between 1942 and 1951, the Federal Reserve put a ceiling on longer-term Treasury yieldsat 2!/2%."

To some of us, these urgent warnings seemed misplaced. They were inconsistentnot only with earlier Fed pronouncements, but also with common sense. In the late 1990s,the Fed could hardly stop talking about free trade and high productivity growth. Theywere unqualified blessings, it said. Digital technology was a time-and-motion man'sdream come true. The fall of communism and the rise of the Internet were openingpreviously shut-in labor markets in Asia and the former Soviet Union. The global supplycurve was shifting downward and to the right.

The sum of these changes pointed strongly to everyday low, and lower, prices fortradable goods and services. Was this not a good thing? Not exactly, the Fed nowdecided. Once the inflation rate approached the zero mark, it might keep falling. And ifprices actually fell, and kept falling, why would anyone go shopping today? They wouldwait for the sales tomorrow. And it must have weighed on Messrs. Greenspan andBernanke that the U.S. economy was increasingly leveraged. Falling prices are good forconsumers, bad for debtors. The United States itself had become a sizable debtor to therest of the world.

Wall Street did not dwell overly long on the possible inconsistencies of the Fed'santi-deflation policy. It focused instead on moneymaking. If Mr. Greenspan, a lifetimeapostle of free markets, was now threatening to muscle 10-year yields down to as low as214 percent, it was an open invitation to buy bonds. Market interest rates, includingmortgage rates, duly plunged.

Interest rates are the traffic signals of a market economy. Green, red or amber,they direct the speed and destination of investment capital. The solid green signals of theearly 2000s channeled capital and labor into residential real estate. The influxtransformed the character of the mortgage market. No more, it seemed, did home buyershave to apply for a loan. More and more, the lenders came to them, whoever they were.Newfangled mortgages—"affordability products," as they were called—threw open thedoors of home ownership to millions of formerly unqualified buyers.

The Fed's low interest rates and the lenders' ingenuity combined to bridge the gapbetween high house prices and not-always-high incomes. If a simple adjustable-ratemortgage could not close the deal, the bankers and brokers had other ideas. OptionARMs, deferred-interest loans and easily accessible junior liens meant that just about

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nobody couldn't qualify. White lies, too, played their part in the drive toward universalhome ownership. So-called low-documentation mortgages put the applicant on his or herhonor. Income? Job title? Years of employment? Your word was your bond. Low-docmortgages became especially popular among subprime buyers. In 1999, according toUBS mortgage research, just 21 percent of low-rated loans were closed with less than fulldocumentation. In the past two years, fully 41 percent were. Wall Street gathered upthese millions of new mortgages, packaged the collateral and modeled the cash flows tocreate asset-backed securities. The scale of this operation is one of the wonders ofmodern finance. Of all the residential mortgages outstanding in the United States, 80percent were originated after 2002. Of all the subprime mortgages outstanding, 75percent were originated after 2003.

Without this interest-rate-assisted mortgage boom (and credit-assistedconsumption boom), job growth in the early 2000s might have been even more sluggish.As it was, according to Asha Bangalore, an economist at Northern Trust Co., housing-related employment generated 43 percent of all private-sector job creation fromNovember 2001 to April 2005. As might be expected, this kind of work has been gettingscarcer. Thus, from November 2001 to January 2007, and housing-related businesseshave produced just 19 percent of all private-sector jobs. The famously adaptable U.S.economy is generating new opportunities.

Adaptability is a very handy quality these days, as the financial traffic lights aresometimes stuck on red or green, a source of con confusion and the occasional financialpileup. Now is one of those difficult times. The Fed's interest rate, 5V4 percent, is thehighest on the Treasury yield curve. The market seems to want a lower structure ofinterest rates, whereas the FOMC is prepared to push higher. The market appears to beless worried about inflation than about the unintended consequences of the mortgagebubble—i.e., rising delinquencies and foreclosures, a nasty downturn in the prices ofsome of the mortgage-backed securities created last year and the risk of contagion in thewider economy. The Fed, for now, will have none of it. It is worried about inflation butsanguine on the economy and the housing situation alike.

Pharmaceutical companies must disclose the side effects of the pills andmedications they advertise, and the purveyors of monetary remedies should be held to asimilar standard of candor. Once, at least, the FOMC seemed to own up to some of theunwholesome consequences of its radical intervention of 2001-04. "Some participants,"said the minutes of the Dec. 14, 2004, FOMC meeting, "believed that the prolongedperiod of policy accommodation has generated a significant degree of liquidity that mightbe contributing to signs of potentially excessive risk-taking in financial marketsevidenced by quite narrow credit spreads, a pickup in initial public offerings, an upturn inmergers-and-acquisition activity and anecdotal reports that speculative demands werebecoming apparent in the markets for single-family homes and condominiums."

These concerns were well-founded, and two years later the "signs of potentiallyexcessive risk-taking" are even more glaring. The subprime mortgage market, aboutwhich we are suddenly hearing so much, has its counterpart in the business world.

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Speculative-grade corporations are borrowing heavily at concessionary interest rates andwith ever less documentation. They, like the subprime mortgage borrowers of 2005 and2006, seem to expect low rates to persist or—at the very least—that the capital marketswill afford them some future opportunity to refinance their debts on terms just asadvantageous as the ones they have recently secured. On the other hand, millions ofsubprime borrowers are discovering that sometimes interest rates go up, and asset pricesgo down.

The Fed owes its public a forthright accounting of the risks it runs with the policyit pursues. I mean the risk that it picks the wrong interest rate, one that sets in motion atrain of adverse events unimagined by the people who imposed the rate in the first place.In all things economic and financial, the Fed is a force for what it likes to call stability.But few things are so ultimately destabilizing as a belief that the world is in for a longspell of peace and quiet.

The Fed, like a good physician, should first do no harm. And, like a good drugcompany, it should not withhold its warnings on side effects. In interest rates as inpainkillers, the secondary reactions can be debilitating.

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Your MasterCard or Your LifeBy Bob HerbertThe New York Times

Monday 22 January 2007

Americans are increasingly living in a house of cards - credit cards.

A disturbing new report shows that with health care costs continuing their sharp rise, low- andmiddle-income patients are reaching for their credit cards with alarming frequency to covertreatment that they otherwise would be unable to afford.

This medical debt, to be paid off in many cases at sky-high interest rates, is being loaded ontoconsumer debt that is already at dangerously high levels. Many families have been crushed bythe load, driven from their homes, forced into bankruptcy, and worse.

The report, released last week, was jointly compiled by Demos, a public policy group in NewYork, and the Access Project, which is affiliated with a health policy institute at BrandeisUniversity and is trying to broaden the availability of health care in the U.S.

Imagine for a moment the seriously ill patient who needs to be hospitalized. In the cold newworld of health care, the primary message to such patients is often "Show me the money!"

In many instances, of course, the patient does not have the money. What the report found isthat even people with health insurance are being drained by health care costs to the point wherethe credit card seems the only option.

"As deductibles and co-payments increase," the report said, "hospitals are finding morepatients unable to pay their medical bills. Some hospital management analysts are expecting anincrease in self-pay patients and are bracing for higher levels of bad debt.

"In recognition of the evolving payment landscape and the risk of hospital bad debt, health careproviders are more aggressively seeking upfront collection of co-pays and deductibles. Acomponent of this strategy is to encourage patients to use third-party lenders such as credit cardsto pay for medical expenses they cannot afford, which families frequently do to meet high medicalbills."

It's one thing to reach for your Visa or MasterCard to pay for a Barbie doll or flat-screen TV. It'sway different to pull out the plastic because you've just learned you have cancer or heart disease,and you don't have any other way to pay for treatment that would prevent a premature trip to thegreat beyond.

A society is seriously out of whack when legalized loan sharks are encouraged to close in onthose who are broke and desperately ill.

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This medical indebtedness is hardly surprising. Health care costs continue to rise much fasterthan family income and inflation, and Americans (who have stopped saving altogether) werealready mired in staggering amounts of personal debt. Some families have been putting theirgroceries on credit cards. Many have taken the financially disastrous step of using home equityloans to bring down credit card balances.

A serious illness for people already in shaky economic circumstances can be the final push intobankruptcy.

According to the report, called "Borrowing to Stay Healthy," about 29 percent of low- andmiddle-income families with credit card debt reported using their credit cards to pay medicalexpenses - in most cases for major medical problems.

Over all, a full 20 percent of low- and middle-income families with credit card debt said theyhad used their cards to cover major medical expenses over the prior three years.

This indebtedness - subject to monthly late fees and penalties, and interest rates that canreach 30 percent - only adds to the trauma of serious illness.

It's believed that 29 million Americans are burdened with medical debt of one form or another.Individuals who are already saddled with medical bills that they can't pay are much more likely toavoid further medical treatment and to leave drug prescriptions unfilled. Such decisions oftenhave life-threatening consequences.

There is an epidemic of personal bankruptcies in the U.S. and medical factors are believed toplay a role in as many as half of them.

These are problems that cry out for reform - of the American health care system and theAmerican way of debt, both of which seriously threaten the American way of life. At the very least,in the short term, we need to protect financially vulnerable patients from a credit card universe inwhich there are no legal limits on fees or interest, and where the abuse of customers is the norm.

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